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Consider a hypothetical economy where there are no taxes and no international trade. Households spend $0.50 of each additional dollar they earn and save the remaining $0.50. If there are no taxes and no international trade, the oversimplified multiplier for this economy is __________

Suppose that the price level in our economy remains the same and that there is still no international trade. Now, however, the government decides to implement an income tax of 5% on each dollar of income. The MPC and MPS, however, remain the same as before. In this case, after accounting for the impact of taxes, the multiplier in this economy is ___________, and a $200 billion decrease in investment spending will lead to a billion in output.

User Ratih
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1 Answer

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Answer:

i) 2

ii) 1.9

iii) $200 billion decrease in investment will lead to a $380 billion decrease in output

Step-by-step explanation:

i) Determine the oversimplified multiplier for this economy

MPC value of the economy = 0.5

spending multiplier = 1 - / 1 - MPC VALUE )

∴ oversimplified multiplier = 1 / 0.5 = 2

ii) Given that the Government implement an income tax of 5%

The Multiplier of the economy = 1 / [ 1 - MPC (1-t) ]

= 1 / [ 1 - 0.5(1-0.05 )]

= 1 / ( 1 - 0.475 ) = 1.9

iii) $200 billion decrease in investment will lead to a $380 billion decrease in output

total change in output = 1.9 * 200 =$ 380

User Papahabla
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