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The marginal propensity to consume (MPC) is 0.8 and government spending decreases by $1 trillion. In this case, the real GDP will decrease by $_____ trillion from the initial effect of the decrease in government spending, and $_____ trillion from the decrease in consumption.

User JC Ford
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Answer:

The correct answer is: $1 trillion; $4 trillion.

Step-by-step explanation:

The marginal propensity to consume is 0.8.

Government spending decreases by $1 trillion.

The real GDP will initially decline by the amount of decline in government spending.

So the decline in the real GDP will initially be $1 trillion.

The overall decrease in the real GDP will be by the size of the spending multiplier.

Total decrease in real GDP

=
\Delta G * (1)/(1-MPC)

=
\$ 1*(1)/(1-0.8)

=
\$1 * (1)/(0.2)

= $5 trillion

Out of this $5 trillion decrease, $1 was initially decreased.

So decline in real GDP due to reduced consumption will be

= $5 trillion - $1 trillion

= $4 trillion

User Basanth
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