Question

Suppose an initial increase in government spending (g) increased gdp by $50,000. if he simple spending multiplier is 2.5, the size of the initial government spending was ______.

Answer 1

The size of the initial government spending was $83,333.33.

Step-by-step explanation:

The simple spending multiplier formula is calculated as:

Multiplier = 1 / (1 - MPC)

Where MPC is the marginal propensity to consume, which is the proportion of each additional dollar of income that is spent rather than saved or taxed.

In this case, we are given that the simple spending multiplier is 2.5. Since the multiplier is equal to 1 / (1 - MPC), we can rearrange the formula to solve for MPC:

MPC = 1 - 1 / multiplier

MPC = 1 - 1 / 2.5

MPC = 1 - 0.4

MPC = 0.6

The marginal propensity to consume is 0.6, which means that 60% of each additional dollar of income is spent. Given that an initial increase in government spending (g) increased GDP by $50,000, we can use the simple spending multiplier to calculate the size of the initial government spending:

Initial government spending = $50,000 / MPC

Initial government spending = $50,000 / 0.6

Initial government spending = $83,333.33