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.

Given is

c = 0.75

t = 0.20

(a) Change in equilibrium income if Government purchases increase by 20

∆Y = [1/1-{c (1-t)}] X ∆G, where ∆G is 20

= [1/1 – {0.75X0.80}] X 20

= 50

(b) Change in equilibrium income if transfers increase by 20

∆Y = (c/1-c) X ∆T

= (0.75/1-0.75) X 20

= 60

9