Question #63445

Given a hypothetical consumption function of the form
Y = C + I0 + G0 ,C = α + β Yd Where: Yd = Y – T, Y = Income, T = Taxes
Government spending and investment are exogenously determined at G and I respectively. Assuming this model represent a three sectors economy, determine Investment multiplier, Government spending multiplier and Tax multiplier. If there is an increase in marginal propensity to consumer, how will this affect the national income?

Expert's answer

Y = C + I0 + G0, C = α + β Yd, where: Yd = Y – T, Y = Income, T = Taxes

Investment multiplier mi = 1/(1 - MPC) = 1/(1 - β).

Government spending multiplier in this case is the same as investment multiplier, so mg = 1/(1 - MPC) = 1/(1 - β).

Tax multiplier mt = MPC/(1 - MPC) = β/(1 - β).

If there is an increase in marginal propensity to consume, then the national income will decrease.

Investment multiplier mi = 1/(1 - MPC) = 1/(1 - β).

Government spending multiplier in this case is the same as investment multiplier, so mg = 1/(1 - MPC) = 1/(1 - β).

Tax multiplier mt = MPC/(1 - MPC) = β/(1 - β).

If there is an increase in marginal propensity to consume, then the national income will decrease.

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