The Multiplier Effect in Economics: Understanding the Impact of Tax Decrease
How does the Marginal Propensity to Consume (MPC) affect the total spending in economics?
The Marginal Propensity to Consume (MPC) plays a significant role in determining the impact of tax changes on total spending. With a MPC of 0.8, how will a $1 billion tax decrease affect total spending?
Answer:
With a MPC of 0.8, a $1 billion tax decrease will eventually increase total spending by $5 billion. This is due to the multiplier effect in economics as more income is spent rather than saved.
Explanation: The question relates to the multiplier effect in economics specifically related to a decrease in taxes. The Marginal Propensity to Consume (MPC) is the amount of a person's change in income that is consumed rather than saved, in this case, 0.8. Thus for a $1 billion tax decrease, the additional amount that will eventually be spent (multiplier effect) will be $1 billion divided by (1 - MPC), which is $1 billion divided by (1 - 0.8). So, the total spending will increase by $5 billion over time.
Therefore, the correct answer is not among the options (A) $800 million, (B) $1 billion, (C) $4 billion, or (D) $8 billion. The total spending increase triggered by a $1 billion tax cut, given a MPC of 0.8, is $5 billion.