Question

If the marginal propensity to save (MPS) is 0.25, investment spending (I) is $600 million, and the government increases its purchases of goods and services (G) by $150 million, then real GDP increases by
A) 200 million
B) $600 million
C) $800 million
D) $2,400 million

Answer 1

Answer: Option (b) is correct.

Explanation:

Given that,

Marginal propensity to save (MPS) = 0.25

Investment spending (I) = $600 million

Government purchases increases by $150 million

MPC - Marginal propensity to consume

MPC + MPS = 1

MPC = 1 - 0.25

= 0.75

Government spending multiplier = $\frac{1}{1 - MPC}$

= $\frac{1}{1 - 0.75}$

= 4

Increase in Real GDP = Government spending multiplier × Increase in government purchases

= 4 × 150

= $600 million