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Question
Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax. Find the change in equilibrium income for the following (a) Government purchases increase by 20 (b) Transfers decrease by 20.
Solution
In case of proportional taxes
(a) `DeltaY=1/(1-c(1-t))xxDeltaG`
MPC = 0.75 and ΔG = 20
`=1/(1-0.75(1-0.2))xx20`
`=1/(1-0.75xx0.8)xx20`
`=20/(1-0.60)`
`=20/0.4=50`
(b) Transfer decreased by 20
`DeltaY=c/(1-c)xxDeltaT`
`=0.75/(1-0.75)xx20`
`=0.75/0.25xx20=60`
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