Question

If $1,000 of additional spending occurs and the marginal propensity to consume is 0.8, the total effect on the economy is an increase of _____ in income or output.

Answer 1

If $1,000 of additional spending occurs and the marginal propensity to consume is 0.8, the total effect on the economy is an increase of $5000 in income or output

In economics, the marginal propensity to consume (MPC) is defined as the proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it. Marginal propensity to consume is a component of Keynesian macroeconomic theory and is calculated as the change in consumption divided by the change in income.

MPC is depicted by a consumption line, which is a sloped line created by plotting the change in consumption on the vertical "y" axis and the change in income on the horizontal "x" axis.

Multiplier = 1 / (1 - MPC)

MPC = Marginal propensity to consume = 0.8

So,

Multiplier = 1 / (1 - 0.8)

=> Multiplier = 5

Changes in income or output = Multiplier * Changes in spending

=> Changes in income or output = 5 * 1,000

=> Changes in income or output = $5,000

Therefore, here the income or output increases by $5,000 in the economy.

Learn more about Marginal propensity here

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