Question

There is a striking similarity between the simple multiplier and the deposit multiplier.

a. Suppose the marginal propensity to spend out of GDP, z, is 0.5. If autonomous spending increases by X dollars, calculate the change in equilibrium income.
b. Explain the relationship between the multiplier, the marginal propensity to spend, and autonomous spending.

Answer 1

The multiplier effect refers to how many times a dollar will turnover in the economy. It is based on the Marginal Propensity to Consume (MPC), which tells how much of every dollar received will be spent. The multiplier is calculated as (1/1 - MPC).

Step-by-step explanation:

The multiplier effect refers to how many times a dollar will turnover in the economy. It is based on the Marginal Propensity to Consume (MPC), which tells how much of every dollar received will be spent. The multiplier is calculated as (1/1 - MPC). For example, if the MPC is 0.8, then the multiplier would be 1/(1-0.8) = 5. This means that for every dollar of autonomous spending, the total increase in equilibrium income would be five times that amount.

The relationship between the multiplier, the marginal propensity to spend, and autonomous spending is as follows:

1. The multiplier is determined by the formula (1/1 - MPC). It represents how much total spending will increase for a given increase in autonomous spending.
2. The marginal propensity to spend (MPS) is the fraction of additional income that is spent. It is equal to 1 - MPC.
3. Autonomous spending is the spending that is not influenced by changes in income. It includes government purchases, investment, and net exports.