Question

Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40.The marginal propensity to consume (MPC) for this economy is ???, and the spending multiplier for this economy is ???.

Answer 1

Answer: Marginal propensity to consume = $0.60

              Spending multiplier = $2.5

Explanation: The MPC can be calculated using following equation :-

$MPC=\frac{change\:in\:consumption}{change\:in\:spending}$

$MPC=\frac{\ 0.60}{\ 1}$

               = 0.60

Similarly, we can calculate spending multiplier as :-

$Spending\:multiplier\:=\:\frac{1}{1-MPC}$

$Spending\:multiplier\:=\:\frac{1}{1-0.60}$

                                            = $2.5