Question

In a closed economy, the MPC is 0.50. Suppose that Government spending increases by $200. Calculate the change in equilibrium income.

Answer 1

In a closed economy with an MPC of 0.50, a $200 increase in government spending will raise equilibrium income by $400, due to the multiplier effect of 2.

Step-by-step explanation:

In a closed economy with a marginal propensity to consume (MPC) of 0.50, an increase in government spending by $200 would lead to a change in the equilibrium income. The formula to calculate the change in equilibrium GDP is the multiplier effect, which in this case is 1/(1-MPC). Therefore, the multiplier is 1/(1-0.5), which equals 2. Applying the multiplier of 2 to the increase in government spending of $200, we find that the change in equilibrium income is 2 x $200 = $400.