Question

Let's say that we are experiencing a recession. How much will the government have to decrease taxes in order to increase GDP by $360 billion if the MPC =.5?

Answer 1

Given, MPC = 0.5

Spending multiplier can be determined using the following formula

$\large MPS = \frac{1}{1-MPC}$

$\large MPS = \frac{1}{1-0.5}$

MPS = 2

Now, determine the tax multiplier using the following formula

Tax Multiplier = - (MPS -1) = -(2-1) = -1

To determine increase in GDP multiply multiplier by decrease in taxes

$\large \triangle GDP = Multiplier*Decrease in Tax$

$\large \$ 360 billion = -1*(-Decrease in Tax)$

$\large Decrease in Tax = \$ 360 billion$

Thus in order to increase GDP by $ 360 billion the Government has to decrease tax by the same amount that is $ 360 billion.

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