9 . Question 6. The multiplier effect

Consider a hypothetical economy. Households spend $0.75 of each additional dollar they earn and save the remaining $0.25. The multiplier for this economy is

.

Suppose government purchases, G, in this economy increase by $300 billion. The increase in Gwill lead to an increase in income, generating an increase in consumption that increases income yet again, and so on.

Fill in the following table to show the impact of the change in Gon the first two rounds of consumption spending and, eventually, on national income.

Note: Use negative signs if numbers are negative.

ChangeinGChangeinG	==	$300billion$300billion
FirstChangeinConsumptionFirstChangeinConsumption	==	billion
SecondChangeinConsumptionSecondChangeinConsumption	==	billion
TotalChangeinIncomeTotalChangeinIncome	==	billion

Now consider the impact of a similar change in taxes. The (absolute value) of the tax multiplier in this question will be

; thus, if taxes change by $300 billion, spending will change by

billion.

Based on your results, this Keynesian model predicts that a change in will have the larger effect on income, given the initial change in planned expenditures is of the same magnitude.