Question

g If the MPC is 3/5 then the multiplier is a. 4, so a $100 increase in government spending increases aggregate demand by $400. b. 1.5, so a $100 increase in government spending increases output by $150. c. 2.5, so a $100 increase in government spending increases aggregate demand by $250. d. 1.67, so a $100 increase in government spending increases output by $166.67.

Answer 1

Answer:

Option (c) is correct.

Explanation:

Marginal propensity to consume (MPC) = 3/5

                                                                  = 0.6

Therefore,

Multiplier = 1 ÷ (1 - MPC)

                = 1 ÷ (1 - 0.6)

                = 1 ÷ 0.4

                = 2.5

Hence, if there is an increase in the government spending by $100, then,

Aggregate demand increases by:

= Change in Government spending × Multiplier

= $100 × 2.5

= $250