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Question
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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Solution
In case of proportional taxes
(a) `DeltaY=1/(1-c(1-t))xxDeltaG`
MPC = 0.75 and ΔG = 20
`=1/(1-0.75(1-0.2))xx20`
`=1/(1-0.75xx0.8)xx20`
`=20/(1-0.60)`
`=20/0.4=50`
(b) Transfer decreased by 20
`DeltaY=c/(1-c)xxDeltaT`
`=0.75/(1-0.75)xx20`
`=0.75/0.25xx20=60`
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