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Calculation of the Multiplier Effect

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What would be the effect of a cut in taxes of $200 billion if the marginal propensity to consume were .9? Why would this policy be different from simply having the government initiate a $200 billion spending program (assuming the income multiplier is 10)? Support your answer with hypothetical calculations.

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Solution Summary

If the Marginal Propensity to Consume (MPC) is known, calculate the total effect of a cut in taxes and compare it with a similar change in government spending.

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When the government begins a spending program, it increases government spending. This stimulates increased consumer spending. The total effect is given by the Spending Multiplier (SM).

SM ...

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