Households within a hypothetical economy have a propensity to spend seventy-five

Question

Households within a hypothetical economy have a propensity to spend seventy-five cents of each additional dollar of disposable income.    Autonomous consumption expenditures are equal to one thousand. Taxes are autonomous and equal to 400. Transfer payments and government expenditures are autonomous and equal to three hundred, and eleven hundred respectively.   Investment, exports, and imports are autonomous; total autonomous expenditures, E0, are equal to six thousand. If the government were to increases taxes by 200, by how much, if at all, will the equilibrium level of output change?

Explanation / Answer

Increase in taxes would lead to a decrease in the equillibrium level of output:

Tax multiplier = - MPC/(1 - MPC)

Change in the level of output = 200 x -0.75/(1 - 0.75) = -600

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