No Bull Economics Lessons

Macroeconomics & Microeconomics Concepts You Must Know

AD/AS and Fiscal Policy (9 of 10)

Question 9:
Suppose that the marginal propensity to save is 0.2 for a closed economy with lump-sum taxes. If the government increases taxes by $200 million, real GDP could decrease by a maximum of:

A.  $40 million
B.  $160 million
C.  $200 million
D.  $800 million
E.  $1 billion

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Correct Answer: D, $800 million. The tax multiplier is MPC/MPS (0.8/0.2 = 4). A tax increase of $200 million when multiplied by 4 will yield a decrease in output of $800 million.