Question

Suppose that an initial $20 billion increase in investment spending expands GDP by $20 billion in the first round of the multiplier process. Also assume that GDP and consumption both rise by $16 billion in the second round of the process. Instructions: Round your answers to 1 decimal place. a. What is the MPC in this economy? b. What is the size of the multiplier? c. If, instead, GDP and consumption both rose by $18 billion in the second round, what would have been the size of the multiplier?

Answer 1

Answer:

a. 0.8

b. 5

c. 0.9 and 10

Explanation:

a. The formula to compute the MPC is shown below:

= (Change in consumption) ÷ (Change in investment income)

= $16 billion ÷ $20 billion

= 0.8

b. The formula to compute the size of the multiplier is shown below:

= 1 ÷ (1 - MPC)

= 1 ÷ (1 - 0.8)

= 1 ÷ 0.2

= 5

c. If the change of the consumption increases, then the MPC would be

= (Change in consumption) ÷ (Change in investment income)

= $18 billion ÷ $20 billion

= 0.9

And, the size of the multiplier would be

= 1 ÷ (1 - 0.9)

= 1 ÷ 0.1

= 10