Answer:
We use the multiplier formula here,
[tex] m=-\frac{MPC}{1-MPC} m=- \frac{0.75}{1-0.75} m=-3 [/tex]
Therefore, we have
[tex] m=\frac{Change in GDP}{Change in Taxes} -3=\frac{Change in GDP}{-$40} Change in GDP= $120 billion [/tex]
While, if the government used a fiscal policy by increasing government spending by $40 billion. The result would have been
[tex] m=\frac{1}{1-MPC} m= \frac{1}{1-0.75} m= 4 [/tex]
Therefore, we have
[tex] m=\frac{Change in GDP}{Change in Government Spending} 4=\frac{Change in GDP}{$40} Change in GDP= $160 billion [/tex]
Therefore, GDP will increase by $160 billion due to an increase in Government spending by $40.
