Question 1
Multiple ChoiceIn a hypothetical economy, the marginal propensity to consume (MPC) is 0.75, and the average tax rate is 10%. If planned government spending is increased by $1.17 billion, the total expected increase in income and spending, in billions, is closest to:
Explanation
To calculate the total impact of government spending on income, we use the fiscal multiplier, which is:
Fiscal Multiplier = \frac{1}{(1 - c × (1 - T))}
Where:
c = marginal propensity to consume = 0.75
T = tax rate = 0.10
Step 1: Calculate the effective MPC after taxes:
Effective MPC = c × (1 - T) = 0.75 × (1 - 0.10) = 0.75 × 0.90 = 0.675
Step 2: Plug into the multiplier formula:
Multiplier = 1 / (1 - 0.675) = 1 / 0.325 ≈ 3.08
Step 3: Multiply the government spending by the multiplier:
Total increase in income = $1.17 billion × 3.08 ≈ $3.60 billion
So, the correct answer is $3.6 billion, making choice B correct.