Question

Assume an open, mixed economy. That is, foreign trade is part of the economy, and the economy includes both a public (government) and a private (consumers and businesses) sector. Given this, aggregate demand is expressed as (C + I + G + X). Assume the MPC is .7. Assume a stimulus package of $100 billion has been approved by Congress and the money has been spent. In order to pay for those expenditures, Congress also approved a $100 billion increase in individual income taxes. (This means Congress would not allow deficit spending in order to stimulate the economy.) Will these actions by Congress expand or contract the economy or are they just useless actions?  

Answer 1

MPC = 0.7 means that for every 1 dollar income, 70 cents is spent and thus saving is 30 cents.

Since , the attempt is to stimulate the economy, hence the gdp amount 100 billion will be synonymous to an increase in total income, say y, by the same amount.

But as MPC is 0.7, therefore 70 billion will be spent. So, the net output is 170 billion but its tax financed, so

net effect = 70 billion increase in total income.

There is increase, so it will expand the economy.