Question

Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to . This decreases income yet again, causing a second change in consumption equal to . The total change in demand resulting from the initial change in government spending is .

Answer 1

Answer:

Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) is 0.80 , and the multiplier for this economy is   5  .

Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to    –$240 billion    . This decreases income yet again, causing a second change in consumption equal to    –$192 billion  . The total change in demand resulting from the initial change in government spending is  –$1.5 trillion   .

Explanation:

Note: This question is not complete. The complete question is therefore provided before answering the question as follows:

Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) is              , and the multiplier for this economy is                .

Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to             . This decreases income yet again, causing a second change in consumption equal to                . The total change in demand resulting from the initial change in government spending is                    .

The explanation of the answer is given as follows:

MPC = The portion of the amount households spend of each additional dollar they earn = 0.80

MPS = Marginal propensity to save = 1 - 0.80 = 0.20

Multiplier for this economy = 1 / 0.20 = 5

Change in government purchase = –$300 billion

Initial change in consumption = Change in government purchase * MPC = -$300 * 0.80 = –$240 billion

Second change in consumption = Initial change in consumption * MPC = –$240 billion * 0.80 = –$192 billion

Total change in demand = Change in government purchase * Multiplier for this economy = –$300 billion * 5 = –$1,500 billion, or –$1.5 trillion