Question

An increase in government spending of $200 million financed by a new tax of $200 million in an economy with a marginal propensity to consume of .90 could result in an increase in nominal GDP (assuming a closed economy with no leakages) of up to how much? (a) $0; (b) $2,000 million; (c) $180 million; (d) $200 million.

Answer 1

Answer:

(d) $200 million.

Explanation:

For computing the increase in nominal GDP first we have to determine the net tax which is equal to

= 0.90 ×$200 million

= $180 million

So, the net increase in government spending is

= $200 million - $180 million

= $20 million

And, we know that

Multiplier = 1 ÷ (1 - MPC)

= 1 ÷ (1 - 0.9)

= 1 ÷ 0.1

= 10      

So, the increase in nominal GDP is

= $20 million × 10

= $200 million