Question

Suppose the government raised taxes by $1,900,000 and simultaneously raised spending by $1,900,000. If the marginal propensity to consume is 0.65, what is the net effect on gross domestic product? (Use a negative number if GDP would go down, and a positive number if GDP would go up)

A) $0
B) $665,000 increase
C) $665,000 decrease
D) $1,900,000 increase

Answer 1

The net effect on GDP will be $0 because the increase in taxes cancels out the increase in government spending and there's no change in autonomous spending to be multiplied by the multiplier effect. The correct option is A.

Step-by-step explanation:

The student asked what the net effect on gross domestic product (GDP) would be if the government raised taxes and spending by $1,900,000, given a marginal propensity to consume (MPC) of 0.65. The net effect on GDP can be determined by taking into account the multiplier effect, which in this case is calculated as 1/(1 - MPC).

With an MPC of 0.65, the multiplier is 1/(1 - 0.65) = 2.857. However, since the increase in taxes cancels out the increase in government spending, there's no initial change in autonomous spending to multiply. Therefore, the net effect on GDP would supposedly be $0, or option A).