Suppose that the marginal propensity to consume is 0.75
a. If the government decreases spending by $500 billion, what is the change in output?
b. If the government decreases taxes by $500 billion, what is the change in output?
c. If the government decreases transfer payments by $500 billion, what is the change in output?
d. If the government decreases spending by $500 billion and at the same time decreases taxes by $500 billion, what is the change in output?
If the MPC = 0.75, the autonomous expenditure multiplier = 1 / (1 - 0.75 ) = 4.
If the MPC = 0.75, the tax multiplier = -0.75 / (1 - 0.75 ) = -3.
If the MPC = 0.75, the transfer payment multiplier = 0.75 / (1 - 0.75 ) = 3.
a. If the government decreases spending by $500 billion, output will decrease by $500 billion × 4 = $2 trillion.
b. If taxes are decreased by $500 billion, output will increase by -$500 billion × -3 = +$1.5 trillion.
c. If transfer payments are decreased by $500 billion, output will decrease by $500 billion × 3 = $1.5 trillion.
d. If the government decreases spending by $500 billion at the same time as decreasing taxes by $500 billion, output will change by (-$500 billion × 4 ) + (-$500 billion × -3 ) = -$500 billion )a decrease of $500 billion), the same amount as the initial decrease in government spending.
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