Question

Assume you save 25% of each additional dollar of income. Congress decides to increase government spending by $100. How much will each additional dollar of government spending increase output (Y)

Answer 1

Answer:

The amount by which each additional dollar of government spending increase output (Y) is 4.

Explanation:

Since you save 25% of each additional dollar of income, we therefore have:

MPS = Marginal propensity to save = 25%, or 0.25

Multiplier = 1 / MPS = 1 / 0.25 = 4

The multiplier is the amount by which each additional dollar of government spending will increase output (Y).

Therefore, the amount by which each additional dollar of government spending will increase output (Y) is 4.

Additional note:

This is not part of the requirement of the question but it is just for you to learn from.

Since we have:

Increase in government spending = $100

Therefore, we have:

Increase in output (Y) = Multiplier * Increase in government spending = 4 * $100 = $400