Question

3. Use the circular flow of income to answer the following question. Assume a consumption function of the form, C=a+b(Y-T). If the marginal propensity to consume is 9 and the government increases taxes by $200, a. Explain (precisely) what happens to the following variables. a) Public Saving b)Private Saving c) National Saving

Answer 1

Given that,

C = a + b (Y - T)

MPC = 0.9

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a) Public Saving is defined as T - G

where T = Tax Revenue, and G = Government Expenditure

For a rise in taxes by 200, Public Saving will also rise by 200 (if G is unchanged)

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b) The rise in taxes decreases disposable income (Y - T) by 200.

MPC is 0.9, thus Consumption falls by 0.9 x 200 = 180

Disposable income could have either been saved or consumed.

Thus, if C falls by 180, Private Saving will fall by 20.

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c) National Saving = Public Saving + Private Saving

= 200 - 20

= 180

Thus, National Saving will rise by 180

answered by: anonymous