Question

In the Keynesian model, when government decreases its spending by $20 billion, and it decreases taxes by $30 billion, and the MPC is .75, by how much will total spending in the economy change?A) Total spending will increase by $70 billion.
B) Total spending will decrease by $270 billion.
C) Total spending will increase by $200 billion.
D) Total spending will increase by $10 billion.
E) Total spending will decrease by $470 billion.

Answer 1

Answer:

D) Total spending will increase by $10 billion.

Explanation:

The computation is shown below:

As we know that

Multiplier = 1 ÷ 1 -MPC

= 1 ÷  1 - 0.75

= 1 ÷ 0.25

= 4

When there is a decrease in tax so the total spending increase is $30 billion

And, the reduction in spending because of the reduction in the government expenditure is $20 billion

So, the increase in total spending is

= $30 billion - $20  billion

= $10 billions

hence, the correct option is D.