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ECO403 VU Assignment No 2 Spring 2012 Solution

Many under developed countries are making their economies strong with the passage of time. Senegal is one of them. After an economic contraction of 2.1% in1990s, Senegal originated a major economic reform program with the support of international donor community (IDC). Senegal is an under developed country located in West Africa. The main industries are food processing, cement, fertilizer, textile and tourism while exports include fish, fabrics and cotton. Major source of revenue of the people of Senegal is tourism and agriculture sector. Known for its mild climate, attractive forest, beaches and great fishing, Senegal has been highly regarded by Europeans and Middle East tourists. Suppose for the development of these places, government of Senegal increased its spending by Rs.7 million. This spending not only attracted the tourists but also increased the consumption, production and employment rate of the people of Senegal. Before this government spending, marginal propensity to consume (MPC) was 0.5 while after this spending, it became 0.7. As marginal propensity to consume had been changed from 0.5 to 0.7, government of Senegal increased the tax rates; which in turn increased the government revenue.
Requirements:
Part A:
Keeping in view the above data, calculate:
a. Government spending multiplier when MPC =0.5 and MPC = 0.7.
b. Tax multiplier when MPC =0.7.
c. Marginal propensity to save (MPS) of this economy when MPC =0.5 and MPC = 0.7
Part B:
a. If government spending increases by 7 million, could total GDP increase by Rs.7 million?
b. If MPC =0.7, by how much amount, GDP will decrease if taxes are increased by 7 million.

Formula to solve the Assignment

multiplier  = -MPC / 1-MPC

GOVT SPENDING MULTIPLIER = 1 / 1-MPC

MPS = 1 / MPC

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