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Impact of Changes in MPC on Equilibrium GDP

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A. Suppose that the economy starts at equilibrium and the

mpc= 0.75. What would be the effect of a $300 increase in government spending once all the rounds of the multiplier process are complete?

b. suppose that the economy starts at equilibrium and the mpc = 0.8.

What would be the effect of a 300 increase in taxes once all the rounds of the multiplier process are complete?

c. Use your answer in 4a and 4b. above to show that:

"When taxes and government spending both increase by the same amount (or decrease by the same amount), the size of the deficit or surplus the government had before remains the same."

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Solution Summary

Examines how changes in MPC change the impact of deficit spending. Also examines how tax changes have a different impact from deficit spending.

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The marginal propensity to consume is the amount that you spend out of each additional dollar you earn. When the government increases its spending by $300, they spend it on goods or services in the economy. Someone will have to produce those goods and services. So they need to hire people to do that, and then pay those people. Those people again spend the money they earn on something else, and so on. This leads to a more than proportionate increase in the ...

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