Question

in an economy with lump-sum taxes and no international trade, if the marginal propensity to consume is 0.8, which of the following is true? a. when consumption increases by $5, investment increases by a maximum of $1. b. when consumption increases by $5, savings increase by a maximum of $1. selected:c. when investment increases by $1, income increases by a maximum of $5.this answer is correct. d. when investment increases by $1, consumption increases by a maximum of $5. e. when income increases by $1, investment increases by a maximum of $5.

Answer 1

In an economy with lump-sum taxes and no international trade, when investment increases by $1, income increases by a maximum of $5.

Step-by-step explanation:

The correct statement is: When investment increases by $1, income increases by a maximum of $5.

In an economy with lump-sum taxes and no international trade, the marginal propensity to consume (MPC) is 0.8. This means that for every additional dollar of income, $0.80 is spent on consumption and $0.20 is saved. When investment increases by $1, it creates an initial increase in income of $1. Since the MPC is 0.8, $0.80 of this increase in income will be spent on consumption. Therefore, when investment increases by $1, income increases by a maximum of $5 ($1 divided by 1 - 0.8).

Answer 2

In an economy with an MPC of 0.8, an increase of $1 in investment could result in a maximum income increase of $5 due to the multiplier effect, and a $5 increase in consumption results in a $1 increase in savings.

Step-by-step explanation:

The concept in question revolves around the marginal propensity to consume (MPC) and its impact on macroeconomic variables in a closed economy with lump-sum taxes. The MPC is defined as the proportion of additional income that a household spends on consumption rather than on saving. In an economy with an MPC of 0.8, the proposition 'c. when investment increases by $1, income increases by a maximum of $5' correctly describes the spending multiplier effect according to the simple Keynesian model. This is because the multiplier is equal to 1 divided by the marginal propensity to save (MPS), which is 1 - MPC. With an MPC of 0.8, the MPS is 0.2, making the multiplier 5 (1 divided by 0.2). As a result, a $1 increase in investment can potentially increase the income by up to $5, which would be the maximum effect under the multiplier principle. Conversely, if the consumption increases by $5, the portion that goes to savings is the complement of the MPC, which reflects the marginal propensity to save (MPS of 0.2), hence option 'b. when consumption increases by $5, savings increase by a maximum of $1' is also true.