Question

Assume that there is an autonomous increase in investment spending of $20 billion and the MPC is given as 0.4, and assuming taxes, imports, and savings are all equal and no leakages:

Answer 1

a. 1.67

b. $33.4 billion

c. A larger MPC

Step-by-step explanation:

a. The Spending Multiplier is used to calculate how much an Economy increases as a result of an extra dollar being put into it and can be calculated by using the following formula;

= 1 / ( 1 - MPC)

= 1/ ( 1 - 0.4

= 1.67

b. Total Change in GDP = Amount invested * Spending Multiplier

= 20 * 1.67

= $33.4 billion.

c. An Economy is helped when it's GDP increases. A higher Marginal Propensity to Consume (MPC) will help it more in that case because from the formula, a larger MPC would reduce the divisor of 1 resulting in a larger Spending Multiplier which will increase the GDP more per dollar.

To explain further, the MPC measures how much of an extra dollar that people in the Economy spend, if the MPC is higher it means they spend more which will contribute to a rise in Consumption which is part of GDP.