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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. |
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Answer» In case of proportional taxes (a) ΔY = 1/(1 - c(1 - t)) x ΔG MPC = 0.75 and ΔG = 20 = 1/(1 - 0.75(1 - 0.2)) x 20 = 1/(1 - 0.75 x 0.8) x 20 = 20/(1 - 0.60) = 20/0.4 = 50 (b) Transfer decreases by 20 ΔY = c/1 - c x ΔT = 0.75/(1 - 0.75) x 20 = 0.75/0.25 x 20 = 60 |
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