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By how much will GDP change, and will GDP be increasing, or will it be decreasing...

By how much will GDP change, and will GDP be increasing, or will it be decreasing if:

MPC = .9 and ↓ Taxes = $7 billion

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Answer #1

Decrease in taxes results in an increase in disposable income.

Increase in disposable income induces households to consume more.

So, consumption expenditure of households will increase.

Consumption expenditure is a component of aggregate demand.

So, increase in consumption expenditure will lead to increase in aggregate demand.

Given the aggregate supply, increase in aggregate demand leads to increase in GDP

So, GDP will increase.

Decrease in taxes by $7 billion will increase the disposable income by $7 billion.

Calculate increase in consumption -

increase in consumption = increase in disposable income * MPC = $7 billion * .9 = $6.3 billion

Multiplier = 1/(1-MPC) = 1/(1-0.7) = 1/0.3 = 3.33

Calculate the increase in GDP -

Increase in GDP = Increase in consumption * Multiplier = $6.3 billion * 3.33 = $20.98 billion

The GDP will increase by $20.98 billion.

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