Question

Suppose that a certain country has an "MPC of 0.8 and a real GDP of $500 billion. If its investment spending decreases by $10 billion, what will be its new level of real GDP?"

Answer 1

Answer:

$450 billion

Explanation:

GDP

The GDP is the total market value of goods and services produced in a country in a given period. It can be determined by adding expenditures made by the government, household, firms and the net export.

Multiplier

The real GDP value will change if there is a change in any of the components that make it up. However, a $ change in its autonomous expenditure will produce more than a proportionate change in the real GDP. The is the called the multiplier effect. The greater amount by which the real GDP will change as a result of a change in any of its components is called the multiplier- it is usually a figure. It is calculated with the formula below:

The multiplier = 1/(1-MPC)

The multiplier figure depends on the MPC as shown above. The MPC is the portion spent from any additional income earned. If I spent only $60 out of a $100 increase in my income, then MPC is 0.6.

Change in real GDP

The maximum amount by which the real GDP will change can be ascertained by the formula below:

Maximum change in real GDP = Multiplier × change in expenditure

Decrease in real GDP = 1/(1-0.8)  × 10 = $50

The new level of GDP = Initial GDP - decrease in GDP

                                   = $500- $50= $450