In the Keynesian-cross model, if the MPC equals 0.75, then a $3 billion decrease in taxes increases planned expenditures by ______ and increases the equilibrium level of income by ______.

Question

Select one:

A.

$3 billion; $3 billion

B.

$2.25 billion; $2.25 billion

C.

$3 billion; $9 billion

D.

$2.25 billion; $9 billion

Answer 1

The answer is D

$3 billion tax decrease will increase disposable income by $3 billion. Since MPC= 0.75, thus consumption will increase by 3*0.75 = $2.25 billion, this is the increase in planned expenditure since other items in the expenditure did not change

Keynesian multiplier = 1/ (1-MPC) = 1/ (1-0.75) = 4

Thus the change in equilibrium income = change in consumption expenditure * multiplier

= 4 * $2.25 = $9 billion