Question

The government raises lump-sum taxes on income by $100 billion, and the neoclassical economy adjusts so that output does not change. if the marginal propensity to consume is 0.6, national saving:_____.

Answer 1

The national savings will fall by $40 million. The amount of taxes raised by the Government is $100 billion. The MPC (marginal propensity to consume) is given to be 0.6.

Government increases $100 as lump-sum taxes.

The result of the Government increasing the taxes will reduce the disposal income by the same amount in this case $100 billion.

Disposal income is Total output - Taxes

MPC  is 0.6

The consumption function is (MPC × T)

                                     = -$100 billion × 0.6

                                     = - $60 billion.

The change in national savings will be -T - ((MPC × T)

                                                          = -100 - (-$60 billion)

                                                          = - $40 billion.

So when the Government increases the lump-sum taxes by $100 billion this will result in the national saving going down by $40 million. The marginal propensity to consume is the measure that the consumption of people changes to a change in their income.

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