Question

Let's say that our government increases government spending by $243 billion, and it also increases taxes by $243 billion. If the MPS is .13, what will be the change in total spending (GDP)?

$486 billion

-$365 billion

$71 billion

$243 billion

$113 billion

Answer 1

Option 4

$243 billion

It increases by $243 billion as one is the balanced budget multiplier so the change in GDP is the same as the change in spending and taxes.

or

By formula:

Marginal propensity to consume (MPC)=1-MPS=1-0.13=0.87

Spending multiplier =1/(1-MPC)=1/(1-0.87)=7.69230769

Tax multiplier =-MPC/(1-MPC)=-0.87/(1-0.87)=-6.69230769

total change in the GDP=spending change * spending multiplier + tax change * tax multiplier

=243*7.69230769+243*(-6.69230769)

=243 billion