Final answer:
The Marginal Propensity to Consume of 0.75 leads to a spending multiplier of 4. An exogenous spending increase of $120 million would result in a $480 million increase in GDP, thanks to the multiplier effect.
Step-by-step explanation:
Understanding the Multiplier Effect
The Marginal Propensity to Consume (MPC) is an economic concept that represents the proportion of an increase in income that a consumer will spend on goods and services as opposed to saving it. If the MPC is 0.75, it implies that for every additional dollar received, a consumer will spend 75 cents and save 25 cents.
To calculate the increase in GDP as a result of an increase in exogenous spending, we use the spending multiplier effect. The formula for the multiplier is 1 / (1 - MPC). With an MPC of 0.75, the multiplier would be 1 / (1 - 0.75) = 4. Therefore, with an increase in spending of $120 million, the total increase in GDP would be $120 million multiplied by the multiplier of 4, resulting in a $480 million increase in GDP.
The concept of the multiplier effect illustrates how an initial increase in spending leads to a larger impact on GDP due to the continuous circulation of money through various economic transactions, as households and firms interact within the economy. This process is a key element of Keynesian economics.