Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax.
Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax. Find the change in equilibrium income for the following (a) Government purchases increase by 20 (b) Transfers decrease by 20.
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In case of proportional taxes
(a) ΔY = 1/(1 - c(1 - t)) x ΔG
MPC = 0.75 and ΔG = 20
= 1/(1 - 0.75(1 - 0.2)) x 20
= 1/(1 - 0.75 x 0.8) x 20
= 20/(1 - 0.60)
= 20/0.4
= 50
(b) Transfer decreases by 20
ΔY = c/1 - c x ΔT
= 0.75/(1 - 0.75) x 20
= 0.75/0.25 x 20
= 60
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