Consider the Keynesian Cross Model with a linear consumption function and a zero tax, where the government purchase is Rs. 100 and the equilibrium income is Rs. 1300. If the government purchase is increased to Rs. 125, the equilibrium income increases to Rs. 1400. Using the given information, the marginal propensity to consume is ______ (round off to two decimal places).
2 marksMacroeconomicsKeynesian cross and the multiplierGovernment spending and tax multipliersModerateabout 2 min
GATE 2023 Question 60: Keynesian cross and the multiplier
Answer and worked solution
Answer: 0.71 to 0.79
The government spending multiplier is:
Since the multiplier equals :
Therefore the marginal propensity to consume is 0.75, within the key's accepted range of 0.71 to 0.79.
The trap: 4.0
Students sometimes stop after computing the multiplier (4) and report that value directly, forgetting the question asks specifically for MPC, which requires one more algebraic step to invert and solve for MPC itself.
Keynesian cross and the multiplier has come up 167 times in 7 exams since 2006.
What this question tests
This question is on Government spending and tax multipliers, part of Keynesian cross and the multiplier in Macroeconomics.
The effect on income of changes in government spending, lump-sum taxes, transfers and income taxes.
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Question from the GATE 2023 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.