If the marginal propensity to consume (MPC) is 0.75 and if policy makers wish to increase real GDP by $300 million to fight a recession, then by how much would taxes have to change?
A) -$30 million
B) -$50 million
C) -100 million
D) -300 million

Question

If the marginal propensity to consume (MPC) is 0.75 and if policy makers wish  to increase real GDP by $300 million to fight a recession, then by how much  would taxes have to change?
A)  -$30 million
B)  -$50 million
C) -100 million
D) -300 million

Quizplus · Accepted Answer

The spending multiplier (1/MPC) can be used to determine how much the government would need to change taxes to achieve a desired increase in real GDP. In this case, the spending multiplier would be 1/0.75 = 1.33. To increase GDP by $300 million, taxes would need to change by -$300 million/1.33 = -$225 million. Therefore, the closest answer choice is answer choice C, which is -$100 million.

If the Marginal Propensity to Consume (MPC) Is 0