Question

In the IS-LM model, if government spending rises by $1,000 and if the marginal propensity to consumer is equal to 0.90, then equilibrium output will rise by

Answer 1

Equilibrium output will rise by $10,000.

Step-by-step explanation:

Marginal propensity to consume (MPC) shows the change in the amount consumption expenditure by consumer as a result of change in the national income.

In order to calculate the amount by which equilibrium output will rise, we need to first calculate the multiplier as follows:

Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.9) = 1 / 0.1 = 10

Since we also have:

Amount of rise in government spending = $1,000

Therefore, we have:

Effect $1,000 rise in government spending on equilibrium output = Amount of rise in government spending * Multiplier = $1,000 * 10 = $10,000

Therefore, equilibrium output will rise by $10,000.