Question

If the marginal propensity to consume is 0.75, by how much would government spending have to rise to increase output by \(1,000 billion? By how much would taxes need to decrease to increase output by \)1,000 billion?

Short answer

Government spending would need to increase, or taxes would have to fall by $250 billion

Step-by-step solution

Multiplier Concept 

It states that increase in income is many times the change in autonomous variables, like increase in government expenditure or decrease in taxes.

Formula = Change in Income

Change (rise) in government expenditure, or fall in taxes

Numerical Solution 

Multiplier = 1 / (1 - MPC)

• As MPC = 0.75

Multiplier 'k' = 1 / (1-0.75)

= 1 / 0.25

k = 4

• As change in income needed = 1000

Let change in investment or tax be = x

4 = 1000 / x

x = 1000 / 4

x, ie Change in Investment or tax needed = 250