Question

An economy has no imports and no​ taxes, the MPC is 0.9​, and real GDP is ​$300 billion.Businesses decrease investment by ​$10 billion.Calculate the new level of real GDP. Explain why real GDP decreases by more than ​$10 billion.The new level of real GDP is ​$nothing billion.Real GDP decreases by more than ​$10 billion because the decrease in investment​ ______.

Answer 1

Real GDP decreases by $100 billion because of the multiplier effect

The new level of GDP will be $200 billion

Step-by-step explanation:

In an economy, there are no exports and no taxes.

The marginal propensity to consume is 0.9.

The real GDP is $300 billion.

There is a decrease in investment of $10 billion.

This $10 billion decrease in the investment will cause the real GDP to decrease by more than $10 billion. This happens because of the working of the multiplier.

Because of a proportionate change in the investment, the multiplier will cause the GDP to change by more than proportionate.

Multiplier

=
`(1)/(1-MPC)`

=
`(1)/(1-0.9)`

= 10

ΔGDP

= Multiplier × ΔI

= 10 × $10 billion

= $100 billion

So a $10 decrease in the investment will cause the real GDP to decrease by $100 billion.

The new level of real GDP will be

= $300 billion - $100 billion

= $200 billion