Question

Suppose the MPC in an economy is 0.7. If taxes were to increase by $10 billion, what would happen to the aggregate expenditure line?

Select one:

a. The expenditure line would shift down by $10 billion

b. The expenditure line would shift up by $10 billion

c. The expenditure line would shift down by $7 billion

d. The expenditure line would shift up by $7 billion

Answer 1

Option C

MPC = Change in Consumption Spending / Change in Income

With increase in taxes income will reduce causing the reduction in expenditure line.

Suppose before taxes Change in Consumption was $700 and Change in income was $1000

MPC = 700 / 1000 = 0.7

After taxes of $10 billion income will reduce

Change in Income will be 1000 - 10 = $990

So, we get

0.7 = Change in Consumption Spending / Change in Income

Change in Consumption Spending = 0.7 * 990

= $693

This shows that Expenditure line has reduced by $7 billion ( $700 - $693)