The Impact of Government Transfers on Equilibrium GDP
What is the effect of a decrease in government transfers to households on equilibrium GDP?
If the MPC is 0.8 and government transfers to households decrease by $50 million, then equilibrium GDP will decrease by:
A. $200 million
B. $150 million
C. $100 million
D. $50 million
Answer:
The equilibrium GDP will decrease by $200 million if the government transfers to households decrease by $50 million.
To calculate the impact of a decrease in government transfers to households on equilibrium GDP, we can use the transfer payment multiplier formula:
Transfer payment multiplier = MPC / (1 - MPC)
Given that the MPC (Marginal Propensity to Consume) is 0.8, we substitute the values into the formula:
Transfer payment multiplier = 0.8 / (1 - 0.8)
Transfer payment multiplier = 0.8 / 0.2
Transfer payment multiplier = 4
Therefore, if the government transfers to households decrease by $50 million, the decrease in equilibrium GDP will be:
Equilibrium GDP will decrease by:
= $50 million * 4
= $200 million
Hence, the equilibrium GDP will decrease by $200 million if the government transfers to households decrease by $50 million.