Question

If firms increase investment by $5 million and the marginal propensity to consume is 0.8, what is the maximum possible change in real GDP?

Answer 1

The maximum possible change in real GDP is $25 million

Step-by-step explanation:

Data provided in the question:

Increase in investment = $5 million

Marginal propensity to consume = 0.8

Now,

Spending multiplier, m = 1 ÷ [ 1 - Marginal propensity ]

or

m = 1 ÷ [ 1 - 0.8 ]

or

m = 5

Therefore,

Increase in GDP = m × Increase in investment

or

Increase in GDP = 5 × $5 million

or

Increase in GDP = $25 million

Hence,

The maximum possible change in real GDP is $25 million