The Impact of Government Transfers on Equilibrium GDP

What is the effect of a decrease in government transfers to households on equilibrium GDP?

If the MPC is 0.8 and government transfers to households decrease by $50 million, then equilibrium GDP will decrease by:

A. $200 million

B. $150 million

C. $100 million

D. $50 million

Answer:

The equilibrium GDP will decrease by $200 million if the government transfers to households decrease by $50 million.

To calculate the impact of a decrease in government transfers to households on equilibrium GDP, we can use the transfer payment multiplier formula:

Transfer payment multiplier = MPC / (1 - MPC)

Given that the MPC (Marginal Propensity to Consume) is 0.8, we substitute the values into the formula:

Transfer payment multiplier = 0.8 / (1 - 0.8)

Transfer payment multiplier = 0.8 / 0.2

Transfer payment multiplier = 4

Therefore, if the government transfers to households decrease by $50 million, the decrease in equilibrium GDP will be:

Equilibrium GDP will decrease by:

= $50 million * 4

= $200 million

Hence, the equilibrium GDP will decrease by $200 million if the government transfers to households decrease by $50 million.