Final answer:
To calculate the multiplier in an economy with given MPC, tax rate, and MPI, one must use the formula 1 / (1 - MPC + MPT + MPI). For the provided values, the spending multiplier would be approximately 1.48. The multiplier indicates the amplification effect of spending in the economy.
Step-by-step explanation:
To calculate the multiplier in an economy with a marginal propensity to consume (MPC) of 0.7, a proportional tax rate of 0.25, and a marginal propensity to import (MPI) of 0.2, we need to understand that the spending multiplier is affected by all these factors. The formula to calculate the spending multiplier is 1 / (1 - MPC + MPT + MPI) where MPT is the marginal propensity to tax, which we get by adjusting the tax rate by MPC (i.e., 0.25 x 0.7 = 0.175). Using these values, the spending multiplier would be calculated as follows:
Spending Multiplier = 1 / (1 - 0.7 + 0.175 + 0.2) = 1 / (0.675) = approximately 1.48.
The multiplier shows how many times a dollar will turnover in the economy based on the MPC. When the MPC is 80% or 0.8, this means that out of every dollar received, $0.80 is spent. The $0.80 then becomes someone else's income, and they spend 80% of that, continuing the cycle. Taxes and imports decrease the overall impact of the multiplier because they represent money that is not spent in the domestic economy but instead is taken by the government or spent on foreign goods.