Question

If the MPC in an economy is 0.75 and aggregate expenditures increase by $5 billion, then equilibrium GDP will increase by?

Answer 1

Answer: D) $20 billion

Explanation: MPC, or marginal propensity to consume represents a person's change in the amount they spent compared to a change in their income. The second existing ratio, is the marginal propensity to save (MPS). This is a person's change in the amount they save compared to a change in their income. These two ratios added together will always add up to 1, as consumers either spend or save (that is don't spend).

In order to calculate the equilibrium GDP increase you need to calculate the multiplier.

This multiplier can then be used to calculate the gross domestic product of a country over time. Gross domestic product, or GDP, is the value of a nation's total goods and services produced within a year.

The mutliplier formula is:

1 ÷ (1-MPC)

= 1 ÷ (1-0.75)

=4

The multiplier is then multiplied with the initial expenditure increase to get the new GDP increase in spending:

4 x $5 billion

= $20 billion.