Question

Suppose that investment demand increases by $300 billion in a closed and private economy (no government or foreign trade). Assume further that households have a marginal propensity to consume of 75 percent. What will be the final cumulative impact on spending? Enter your answer in billions. For example if your answer is $600 billion then enter 600. If your answer is $1,500 then enter 1500.

Answer 1

See steps below

Step-by-step explanation:

Step A

Multiplying the initial investment demand of $300 billion by the MPC of 0.75 results in the change in spending for cycle two ($300 billion x .75= $225 billion).

Repeat this for each consecutive round. Round 3: $225 billion x .75= $168.75 billion. Round 4: $168.75 billion x .75 = $126.56 billion

Step B

$1,200 billion: The multiplier is 1 / (1 - MPC)= 1 / (1 - 0.75) = 4, which is multiplied by the $300 billion change