Question

Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40.The marginal propensity to consume (MPC) for this economy is ???, and the spending multiplier for this economy is ???.

Answer 1

Answer: Marginal propensity to consume = $0.60

Spending multiplier = $2.5

Explanation: The MPC can be calculated using following equation :-

`MPC=(change\:in\:consumption)/(change\:in\:spending)`

`MPC=(\$0.60)/(\$1)`

= 0.60

Similarly, we can calculate spending multiplier as :-

`Spending\:multiplier\:=\:(1)/(1-MPC)`

`Spending\:multiplier\:=\:(1)/(1-0.60)`

= $2.5