Worksheet 2

National Income determination in Closed Economy

1.What is the value of the tax multiplier if the MPC is 0.80? ____-4

-b/1-b or –MPC/MPS or –mpc/1-mpc

-0.8/0.2= -4

2. What is the value of the government spending multiplier if the MPC is 0.67?_____3

1/MPS OR 1/1-MPC= 1/1-.67= 1/.33= 3

3. What is the tax multiplier if the MPS is 0.25?____________-3

-b/1-b= -0.75/0.25= -3

4. The numerical value for the investment and government spending multiplier increases as the
(A) value of the marginal propensity to save decreases.
(B) value of the average propensity to consume increases.
(C) value of the marginal propensity to consume decreases.
(D) value of the marginal propensity to save increases.
(E) value of the average propensity to consume decreases.

5. If the government spending multiplier is 5 in a country, the value of the tax multiplier must be
(A) 5
(B) 4
(C) 1
(D) –4
(E) –5

Sol 5= 1/1-b = 1/MPS

So 1/MPS= 5

MPS=1/5 OR .02

So MPC=0.8

SO – MPC/MPS= -0.8/0.2=-4
6. A country has the following values for income and consumption. Use table no1 to answer questions 6
,7 and 8.Use Table No. 1

Income Consumption
100 150

200 225
300 300
400 375
500 450

600 525

The government spending multiplier in a country is

(A) 3
(B) 4
(C) 5
(D) 10
(E) 30

1/1-b= 1/.25= 4

7. Use Table No. 1 Table No1.

Income Consumption
100 150

200 225
300 300
400 375
500 450

600 525

If there is an increase in taxes of $200 in a country, the decrease in GDP will be

(A) $100
(B) $200
(C) $400
(D) $600
(E) $800

Use tax multiplier = -b/1-b= -.75/1-.75= -3

So if ∆T= 200 then ∆Y/∆T= -3 so REAL GDP Will decline by $ 600

8. Use table no. 1.If there is an increase in government spending of $100 and an increase in taxes of $100
in a country, then the change in GDP will be
(A) $50
(B) $100
(C) $200
(D) –$100
(E) –$200

Balanced budget multiplier ∆Y= ∆G= $100

Table No1.
Income Consumption
100 150

200 225
300 300
400 375
500 450

600 525

10 . Would the multiplier be larger or smaller if you saved more of your additional income? SMALLER
AS MORE LEAKAGE FROM CIRCULAR FLOW OF INCOME AND EXPENDITURE.

OR 1/1-B SO SMALLER MPC WILL LEAD TO LESSER VALUE OF MULTIPLIER

11. What do you think would happen if all people in a country saved all of the change in their incomes?

THERE WOULD NOT BE ANY CHANGE IN OUTPUT OR Real GDP . Multiplier value would be zero

12. What would happen if you spent all of the change in your income?
Figure 1
Changes in APC and MPC as DI Increases
Disposable Consumption Savings APC APS MPC MPS
income
$10000 $12000 -$2000 C/DI= - - -
12000/10000= 2000/10000=-
-1.2 .20
20000 21000 -1000 -1.5 -0.05 .90 .1
30000 30000 1.00 1 0 .90 .1
40000 Y-C= 40000- 1000 .975 .025 .90 .1
10000= 39000
50000 48000 2000 .96 .04 .90 .1
60000 57000 3000 .95 .05 .90 .1
 70000 66000 Y-C= .94 .06 .90 .1
70000-
66000=4000

13. Complete Figure 1 and answer the questions based on the completed table.
14. What is the APC at a DI level of $10,000? _1.20 ___________ At $20,000? ____1.05 ________
15. What happens to the APC as DI rises? It decreases.
16. What is the MPC as DI goes from $50,000 to $60,000? ___0.90 ________ From $60,000 to $70,000?
_______0.90 ______
17. What happens to MPC as income rises?_______ It remains constant. _______ What happens to MPS
as income rises? It remains constant.

18. What is the conceptual difference between APC and MPC? The APC measures the average
consumptionat any level of disposable income. The MPC measures what proportion of each additional
RUPEE of income consumers will spend.

Activity 1

Table 2 : Income-Expenditure Schedule

Total Spending
Income
Income output Consumption Investment Government Total Spending
spending Spending Spending (Aggregate
Expenditure)
$2400 $2500 $300 $100 $2900
2600 2600 300 100 $3000
2800 2700 300 100 $3100
3000 2800 300 100 $3200
3200 2900 300 100 $3300
3400 3000 300 100 $3400
3600 3100 300 100 $3500
3800 3200 300 100 $3600

1. Use the data given in table 2 on consumption spending and income to draw the consumption function
on the graph . Label the function C.

2. Using the consumption function you have just drawn and the data on investment and government
spending, draw the aggregate expenditure schedule on the same graph. Label it AE (C + I + G).What is
the difference between the aggregate expenditure schedule and the consumption function?
$400: the sum of government spending (G) and investment spending (I)

3. Now draw a line representing all the points at which total spending and income could be equal. Label
this the 45° line.
LOOK BELOW THE QUESTION
4. The 45° line represents all the points that could be the equilibrium level of total spending. Now circle
the one point that is the equilibrium level of total spending. What is the equilibrium level of total
spending on your graph? INCOME SPENDING= AGGREGATE SPENDING
$3,400 billion