Question

# The marginal propensity to consume is 0.5 as above. The federal government wants to increase GDP...

The marginal propensity to consume is 0.5 as above. The federal government wants to increase GDP by \$100 billion. By how much should government spending be increased? Suppose instead that the government wants to achieve the same goal of increasing GDP by \$100 million. Assuming lump-sum taxation, what is the required tax cut in order to reach the target GDP?

Government spending multiplier = 1/(1- MPC) = 1/(1 - 0.5) = 1/0.5 = 2

Change in GDP = change in government spending * spending multiplier

Or, \$100 billion = change in government spending * 2

Or, Change in government spending = \$50 billion

Therefore, the government spending should be increased by \$50 billion.

Tax multiplier = -MPC/(1 - MPC) = -0.5/(1 - 0.5) = -0.5/0.5 = -1

Change in real GDP = change in taxes * tax multiplier

Or, \$100 million = change in taxes * -1

Or, change in taxes = - \$100 million

Therefore, the government needs to cut taxes by \$100 million.

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