Question

Suppose that in an economy, net taxes and government spending are independent of income. It is determined that when government spending decreases by exist100 billion, income falls by exist1000 billion. In this economy the value of the MPS = ______. Enter your response rounded to two decimal places.) In this economy the value of the MPC = _____. (Enter your response rounded to two decimal places.)

Answer 1

(1) In a closed economy, assuming investment demand is zero,

Y = C + G

Y - C = G

S = G, where

Y: Income, C: Consumption, S: Savings and G: Government spending

So,

S / Y = G / Y [dividing each side by Y]

`\Delta \mathrm{S} / \Delta \mathrm{Y}=\Delta \mathrm{G} / \Delta \mathrm{Y}`

MPS = $100 billion / $1000 billion = 0.10

(2) MPC = 1 - MPS = 1 - 0.10 = 0.90