Question

The government raises taxes by $100 billion. If the marginal propensity to consume is 0.6, what happens to the following? Do they rise or fall? By what amounts? a. Public saving. b. Private saving.

Answer 1

(b) Increases by $100 billion.

(b) Decreases by $40 billion.

Step-by-step explanation:

Given that,

Taxes rises by the government = $100 billion

Marginal propensity to consume, MPC = 0.6

(a) Public savings refers to the savings that is done by the government. It is calculated as the difference between government spending and taxes collected by the government.

Government spending = $0

So, the public savings increases by $100 billion.

(b) Private savings refers to the savings that is done by the households.

Change in consumption(Falls):

= MPC × Increase in taxes

= 0.6 × $100 billion

= $60 billion

Private savings:

= Income - Taxes - Consumption

= $0 - $100 billion - (-$60 billion)

= -$100 billion + $60 billion

= - $40 billion

Therefore, the private savings decreases by $40 billion.