Please provide a guided answer or a brief explanation your h

Please provide a guided answer or a brief explanation, your help is very appreciated.

The national economy is in the state of equilibrium, Marginal propensity to consume MPC-0.75 How will the equilibrium level of GDP change, if 1. The government increases its spending by 2 million euros? 2. The government reduces taxation rate and amount of taxes collected decreases by 2 million euros? 3. In which case (1 or 2) there wil be higher effect on GDP?

Solution

We are given that MPC is 0.75. This implies that spending multiplier is 1/1-MPC = 1/1-0.75 = 1/0.25 = 4. Similarly tax multiplier is -MPC/1-MPC = -0.75/1-0.75 = -0.75/0.25 = -3.

1) When the government increases its spending by 2 million euros, the change in equilibrium level of GDP is measured by Y/G = 1/1-MPC

Y/2 = 4

This gives the result that equilibrium level of GDP is increased by 8 million euros.

2) Now tax multiplier is -3. When taxes are reduced 2 million euros, the equilibrium level of GDP is changed by

Y/T = -MPC/1-MPC

Y/-2 = -3

This gives the result that equilibrium level of GDP is increased by 6 million euros.

3) Spending multiplier is more than tax multiplier so the effect of increase in government spending is more on the GDP. This is seen from the increase in equilibrium level of GDP, which is increased by 8 million euros in government spending and which is more than the increase in equilibrium level of GDP by 6 million euros when taxes are reduced.