Question

Assume that the economy is at equilibrium at $10 trillion, with a marginal propensity to consume of 0.75. If exports rise by $0.5 trillion and imports increase by $0.7 trillion, equilibrium income will: a. fall by $0.2 trillion. b. not change. c. fall by $0.8 trillion. d. rise by $2 trillion.'

Answer 1

Answer:

Option (c) is correct.

Explanation:

Multiplier effect = 1 ÷ (1 - marginal propensity to consume)

                           = 1 ÷ (1 - 0.75)

                           = 4

Net exports = Exports - Imports

                    = 0.5 - 0.7

                    = (-0.2)

Impact on the equilibrium income  = Net exports × Multiplier effect

                                                          = (-0.2) × 4

                                                           = (-0.8),

so, the equilibrium income will fall by $0.8 trillion.