Question

Suppose that the marginal propensity to consume in Frugalia is 0.60. The government of Frugalia enacts a stimulus program that increases spending by $10 million. By how much will aggregate expenditures increase in Frugalia?
a) $4 million
b) $10 million
c) $25 million
d) $40 million

Answer 1

Answer:

option (c) $25 million

Explanation:

Data provided in the question:

The marginal propensity to consume in Frugalia, MPC = 0.60

Increase in spending = $10 million

Now,

The total increase in income

= $\frac{\textup{1}}{\textup{1-MPC}}$  × Increase in spending

on substituting the respective values, we get

= $\frac{\textup{1}}{\textup{1-0.6}}$  × $10 million

=  $\frac{\textup{1}}{\textup{0.4}}$  × $10 million

or

= 2.5 × $10 million

or

= $25 million

Hence,

The answer is option (c) $25 million