If these economists ignore the possibility of crowding out, they would estimate the marginal propensity to consume be MPC.
New estimate of the MPC would be 4 to 2.67.
Crowding out effect and Marginal Propensity to Consume (MPC)
Initial Estimate of MPC without Crowding Out:
When economists observe a $15 billion increase in government spending leading to a $60 billion increase in total demand for goods and services, they might initially calculate the MPC as follows:
MPC = Change in Consumption / Change in Income
MPC = $60 billion / $15 billion
MPC = 4
This suggests that for every dollar increase in income (government spending in this case), individuals increase their consumption by $4.
New Estimate of MPC with Crowding Out:
However, the crowding-out effect suggests that increased government spending can "crowd out" private investment and consumption. This means that as government spending increases, businesses and individuals may borrow less and reduce their spending, offsetting some of the initial increase in demand.
Therefore, when economists consider the possibility of crowding out, they need to adjust their estimate of the MPC. They need to account for the fact that not all of the increased demand due to government spending translates to actual consumption.
Calculating the New MPC:
Let's assume that the crowding-out effect reduces the actual increase in consumption by $20 billion. This means that the actual increase in consumption is $40 billion instead of $60 billion.
Therefore, the new estimate of the MPC would be:
New MPC = $40 billion / $15 billion
New MPC = 2.67