Question

The government spends $10 billion on submarines. The marginal propensity to consume is 3/4. Based on the multiplier effect, how much does the $10 billion increase in G generate in terms of an increase in Y; that is, an increase in demand for goods, services, and structures? Please report your answer in billions of dollars.

Answer 1

The $10 billion increase in government spending will generate a $40 billion increase in demand in the economy when the marginal propensity to consume is 3/4 due to the multiplier effect.

Step-by-step explanation:

The government spends $10 billion on submarines, and the marginal propensity to consume (MPC) is 3/4. To calculate the total increase in demand (Y) due to the multiplier effect, you use the formula for the spending multiplier:

Multiplier = 1 / (1 - MPC)

In this case, it would be:

Multiplier = 1 / (1 - 3/4) = 1 / (1/4) = 4

Now, multiply the government spending by the multiplier:

Increase in Y = Government Spending × Multiplier = $10 billion × 4 = $40 billion

As a result, the $10 billion increase in government spending generates a $40 billion increase in demand for goods, services, and structures.