Question

Assume that the marginal propensity to consume out of disposable income is 0.8 and that the government taxes all income at a constant rate of 30 percent. if gross income increases by $100, consumption will initially increase by

(a) $44
(b) $56
(c) $70
(d) $80
(e) $100

Answer 1

When gross income increases by $100, with a tax rate of 30% and a marginal propensity to consume of 0.8, consumption initially increases by $56 (b).

Step-by-step explanation:

The student has asked about the initial increase in consumption when gross income increases by $100, given a marginal propensity to consume (MPC) of 0.8 and a constant tax rate of 30%.


To find the initial increase in consumption, you must first calculate the amount of disposable income after taxes and then apply the MPC to this figure.

The calculation process is as follows:

1. Calculate the amount of taxes: $100 × 30% = $30.
   
   
2. Subtract the taxes from the gross income to find the disposable income: $100 - $30 = $70.
   
   
3. Apply the MPC to the disposable income: $70 × 0.8 = $56.
   
   

Therefore, if gross income increases by $100, consumption will initially increase by $56, which corresponds to option (b).