Question

Use the expenditure multiplier to calculate the change in AD that would result from a $100 million increase in government spending if the MPC = 0.8. How would the same change in spending affect AD if the MPC = 0.95?

Answer 1

Answer:

If MPC is 0.8, Change in GDP    =  $500 million

If MPC is 0.95, Change in GDP =  $2,000 million

Explanation:

Expenditure Multiplier is the amount by which the real GDP will change if autonomous expenditure changes by a given amount.

It is calculated as follows: 1/(1-MPC).

MPC is the portion of additional income that is spent. If the MPC is 0.8, then the expenditure multiplier will be = 1/(1-0.8) = 5

Using the first scenario with an increase in government spending by $100million, the resulting change in GDP would be

Change in GDP =  change in autonomous expenditure × Multiplier

                          = 100 ×  5 = $500 million

Scenario 2, MPC of 0.95

Expenditure Multiplier = 1/(1-0.95) = 20

Change in GDP= 100 × 20 = $2000 million