Question

In a certain economy, when income is $500, consumer spending is $375. The value of the multiplier for this economy is 5. It follows that, when income is $510, consumer spending is:________

a. $166.75
b. $175.00
c. $151.25
d. $170.20

Answer 1

The options are wrong, if consumer spending is $375 when income is $500, it has to be higher if income increases (it cannot be lower).

Consumer spending at $510 = $383

Step-by-step explanation:

the economy's multiplier = 1 / MPS (marginal propensity to save)

5 = 1 / MPS

MPS = 1 / 5 = 0.2

MPC (marginal propensity to consume) = 1 - MPS = 1 - 0.2 = 0.8

consumer spending at $510 = consumer spending at $500 + [$510 - $500) x 0.8] = $375 + ($10 x 0.8) = $375 + $8 = $383

MPC measures how much consumer spending increases if total disposable income increases.