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Marginal Propensity to consume and to save

(See attached file for full problem description)

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HYPOTHETICAL INCOME DATA (BILLIONS OF DOLLARS)
(NET EXPORTS IS ASSUMED TO BE ZERO)

Y (GDP) C I G
$0 $100 $80 $60
100 175 80 60
200 250 80 60
300 325 80 60
400 400 80 60

QUESTIONS

1. What is the value of the MPC (marginal propensity to consume)?

2. What is the value of MPS (marginal propensity to save)?

3. What is the value of the:
a. government expenditure multiplier
b. investment expenditure multiplier

4. If the economy is in equilibrium at $960 billion, what is the level of Saving?

5. Assuming an equilibrium of $960 billion, what is the new equilibrium if government expenditures increase by $25 billion?

6. Assuming an equilibrium of $960 billion, what is the new equilibrium if a lump sum tax of $20 billion is imposed?

HINTS:

1. The multipliers for government expenditures (G), investment spending by businesses (I), and net exports (XN) all have the same value and are calculated as 1 divided by the MPS (marginal propensity to save).
2. There is a tax multiplier and its value is one less than the multiplier for government expenditures (G). Also, the tax multiplier has a negative sign, since increasing taxes decreases GDP (Y).
3. In equilibrium saving (S) is equal to investment spending by businesses (I) plus government expenditures (G). S = I + G.
4. An increase in government spending (G) or investment spending by businesses (I) raises equilibrium GDP (Y) by the amount of the increase times the multiplier.
5. A decrease in government spending (G) or investment spending by businesses (I) lowers equilibrium GDP (Y) by the amount of the decrease times the multiplier.
6. A lump sum tax decreases equilibrium GDP (Y) by the amount of the tax times the tax multiplier.
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Attachments

Solution Preview

HYPOTHETICAL INCOME DATA (BILLIONS OF DOLLARS)
(NET EXPORTS IS ASSUMED TO BE ZERO)

Y (GDP) C I G
$0 $100 $80 $60
100 175 80 60
200 250 80 60
300 325 80 60
400 400 80 60

QUESTIONS

1. What is the value of the MPC (marginal propensity to consume)?
MPC = CHANGE IN CONSUMPTION/ CHANGE IN INCOME
= 75/100=.75
2. What is the value of MPS (marginal propensity to save)?
MPS=1-MPC=.25
3. What is the value of the:
a. government expenditure ...

Solution Summary

This explains the computation of key economic concepts such as Marginal Propensity to consume and to save. This also discusses the concept of multiplier.

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