Question

If a $500 billion increase in investment spending increases income by $500 billion in the first round of the multiplier process and by $450 in the second round, income will eventually increase by _________.

Answer 1

Answer:

450 billion

Explanation:

Marginal Propensity to consume (MPC) is a ratio that measure much the investment in the economy is consumed.

Marginal Propensity to save (MPS) is a ratio that measure much the investment in the economy is saved

Marginal Consumption = $500 billion - 450 billion = 50 billion

Spending ratio = 50 / 500 = 0.1

Marginal Propensity to consume (MPC) = 0.1

Marginal Propensity to save (MPS) = 1 - 0.1 = 0.9

Spending Multiplier = 1 / MPS  = 1 / 0.9 = 1.11

First Round of Multiplier

Spending 500 billion increase income 500 billion

after consuming 50 billion

In second round Spending 450 billion will increase the income by 450 billion