In the Keynesian-cross model,if the MPC equals .75,then a $1 billion decrease in taxes increases planned expenditures by ______ and increases the equilibrium level of income by ______.
A) $1 billion; more than $1 billion
B) $.75 billion; more than $.75 billion
C) $.75 billion; $.75 billion
D) $1 billion; $1 billion

Question

Quizplus · Accepted Answer

According to the Keynesian-cross model, the change in equilibrium income resulting from a change in autonomous expenditures (like a change in taxes) is given by the formula: ΔY = ΔA / (1 - MPC), where MPC is the marginal propensity to consume.

In this case, ΔA (the change in autonomous expenditures resulting from a $1 billion decrease in taxes) is -$1 billion (since taxes are decreasing, autonomous expenditures are decreasing), and MPC is 0.75.

Plugging these values into the formula, we get: ΔY = (-$1 billion) / (1 - 0.75) = (-$1 billion) / 0.25 = -$4 billion.

This means that planned expenditures increase by $0.75 billion (the amount of the tax cut times the MPC), but equilibrium income increases by more than that - specifically, by $4 billion. Therefore, the best answer is B.

In the Keynesian-Cross Model,if the MPC Equals