Assume taxes increase by $300 and government spending increases by $300. The marginal propensity to consume is 0.75. Calculate the total change GDP.

Total change in GDP = $360

Explanation:

To calculate the effect of an increase in public spending and an increase in taxes, we need to calculate the respective multipliers.

Tax multiplier represents the multiple by which gross domestic product (GDP) increases (decreases) in response to a decrease (increase) in taxes.

The formula is:

TMs=MPC/MPS=MPC / (1-MPC)

TMs = is the simple tax multiplier;

MPS = marginal propensity to save (MPS); and

MPC = marginal propensity to consume.

Spending multiplier represents the multiple by which GDP increases or decreases in response to an increase and decrease in government expenditures and investment.

The formula is:

Spending multiplier = 1/MPS=1 / (1-MPC)

Tax multiplier = 0,75/0,25 = 2,8

Spending multiplier = 1/0,25=4

Change in GDP (by tax increase) = tax multiplier*change in tax

=2,8 * (-300) = -840

Change in GDP (by government spending increase) = spending multiplier*increase in government spending = 4*300=$1200

Total change in GDP=1200-840 = $360