Suppose that the government hires additional police officers and pays them 100.

Question

Suppose that the government hires additional police officers and pays them 100. Shortly thereafter, we observe that police officers' spending on consumer goods rises by 64 and their saving rises by 16. We also observe an increase in tax revenues of 20.

Calculate the eventual total increase in output in this example. [Hint: think of the steps of the multiplier process that I went through in class. What is the tax rate implied by the numbers I gave you above? What is the MPC? What is the implied multiplier?

Explanation / Answer

MPC=64/80=.80 MPS=16/80=.20

dY=dAD=cy+c^2y+c^3y+......=y(1+c+c^2+c^3+....)

dy/dAD=1/.20=5

New Y = 5*84=420

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