If the MPC is 0.5 and the tax rate is 10%,a $500 increase in autonomous government purchases will increase equilibrium income by
A) $225.
B) $280.
C) $910.
D) $1110.

Question

Quizplus · Accepted Answer

The government spending multiplier is given by:
1 / (1 - MPC(1 - t))
where MPC is the marginal propensity to consume and t is the tax rate.
Plugging in the given values, we get:
1 / (1 - 0.5(1 - 0.1)) = 1 / 0.8 = 1.25
Therefore, a $500 increase in government purchases will increase equilibrium income by:
1.25 x $500 = $625
However, since there is a 10% tax rate, $62.50 of this increase will go towards taxes, leaving a net increase in disposable income of $562.50.
Therefore, the final increase in equilibrium income will be:
$500 + $562.50 = $1062.50
Rounding this off to the nearest hundred gives us $1100, which is closest to option C) $910.

If the MPC Is 0