Question

The Queen of Genovia wants to enact some new economic policies to the country. She wants...

The Queen of Genovia wants to enact some new economic policies to the country. She wants to raise taxes by $400 to have an impact on the economy. Would it matter if the MPC were 0.25, 0.75, or 0.80?

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Answer #1

yes, the value of MPC matter for the overall impact on the GDP due to a tax change

Tax multiplier = -MPC/(1-MPC)

Thus, the effect on final output is as follows due to different MPCs and a $400 tax increase

MPC = 0.25: change in GDP = 400*(-0.25/0.75) = -$133.33

MPC = 0.75: change in GDP = 400*(-0.75/0.25) = -$1200

MPC = 0.8: change in GDP = 400*(-0.8/0.2) = -$1600

Thsu, the higher the MPC, the higher will be the negative impact of an increase in taxes on the output

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