Changes in Government Purchases

Real GDP demanded is an inflation-adjusted measure which reflects value of all services and goods produced in a certain year which is expressed in base-year prices(Hansen, 2003). It accounts for changes in price level and provides more accurate figure as compared to nominal GDP.Marginal propensity to consume abbreviated as MPC is the proportion of aggregate raise in pay a consumer spends on consumption of goods and services as opposed to saving it. It is computed by dividing change in consumption by change in disposable income that caused it.A decrease in the marginal propensity to consume will decrease the real GDP demanded(Hansen, 2003).

The government spending multiplier is 1/MPs while the taxation multiplier is (1/MPs-1) and MPC + MPS=1, with MPC=0.9,MPS=0.1 the multiplier is 1/0.1=10. If the government purchases decreases by 10BGDP will decline by $10B*10= $100B. The tax multiplier is MPC/1-MPC=0.9/1-0.9=9. Increase in tax will decrease the income by 9*10=$90B.

With MPC=0.8 and MPS=(1-0.8)=0.2, the multiplier is 1/0.2-1=5. Change in level of real GDP demanded for MPC 0.8 is $10B*5=$50B. The tax multiplier will be MPC/1-MOC=1/0.2-1=4. Increase in tax will decrease the income by 4*10=$40B.

With MPC of 0.75 and MPS of 1-0.75=0.25, the multiplier is 1/0.25=4. Change in level of real GDP demanded for MPC of 0.7 is $10B*4=$40B. The tax multiplier is MPC/1-MPC=1/0.25-1=3. Increase in tax will decrease the income by 3*10=$30B.

With MPC of 0.6, the MPS=0.4, the multiplier is 1/0.4=2.5. Change in level of real GDP demanded for MPC of 0.6 is $10B*2.5=$25B. The tax multiplier is MPC/1-MPC=1/0.4-1=1.5. Increase in tax will decrease the income by 1.5*10=$15B.

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