Question

PART 1

Suppose the government increases education spending by $30 billion. If the marginal propensity to consume is 0.75, how much will total spending increase?

Instructions: Enter your response as a whole number.

$_________ billion

PART 2

	NEWS WIRE	FISCAL RESTRAINT
	Retailers Bracing for Spending Slowdown
	Retailers across the country are bracing for an anticipated slowdown in consumer spending. As of January 1, the Social Security payroll tax rate moved back up from 4.2 to 6.2 percent. That will reduce take-home pay by about 2 percent. That means that the 153 million workers in this country will have an average of $1,500 less to spend this year. For retailers, that implies less spending on groceries, household goods, and dining out. According to an estimate by Citigroup, the jump in the payroll tax will leave $110 billion less in consumers’ pockets. That has retailers worried.
	Source: News accounts of January 2013.
	If the MPC was 0.90, and using the Citigroup estimate,
	a. how much did consumer spending decline initially in response to the 2013				billion
	payroll tax hike?
	b. what was the ultimate decline in aggregate demand after all multiplier effects?				billion

Answer 1

1) MPC= 0.75

Government spending Multiplier= 1/(1-MPC)= 1/(1-0.75)= 4.

Increase in total spending= Government Spending Multiplier× Increase in education Spending

Increase in total spending= 4× $30 billion= $120 billion

2)a) Decrease in Disposable Income= $110 billion

MPC= 0.90

Decrease in Consumer Spending initially= MPC× Decrease in Disposable Income

Decrease in Consumer Spending Intially= 0.90×110= $99 billion

Consumer spending declined initially by $99 billion

b) Tax Multiplier= -0.90/(1-0.90)= -9

Decrease in Aggregate Demand= Tax Multiplier× Change in Taxes

Decrease in Aggregate Demand= -9× -110= $990 billion

Ultimate decline in Aggregate Demand after all Multiplier effects is $990 billion.