Question

Suppose that an initial $40 billion increase in investment spending expands GDP by $40 billion in the first round of the multiplier process. Also assume that GDP and consumption both rise by $32 billion in the second round of the process.
A. What is the MPC in this economy?
B. What is the size of the multiplier?
C. If, instead, GDP and consumption both rose by $32 billion in the second round, what would have been the size of the multiplier?

Answer 1

Answer:

A. What is the MPC in this economy?

• Marginal propensity to consume (MPC) = increase in consumption in the second round / initial investment spending increase = $32 / $40 = 0.8

B. What is the size of the multiplier?

• multiplier = 1 / (1 - MPC) = 1 / (1 - 0.8) = 1 / 0.2 = 5

C. If, instead, GDP and consumption both rose by $32 billion in the second round, what would have been the size of the multiplier?

• the same as A and B, since the question already states that consumption increased by $32 billion in the second round: MPC = 0.8, and multiplier = 5

Answer 2

A. The MPC in this economy $32 / $40 = 0.8

B. The size of the multiplier  1 / 0.2 = 5

C. $32 billion in the second round: MPC is = 0.8, and multiplier = 5

What is GDP?

A. When the Marginal propensity to consume (MPC) is = increase in consumption in the second round / initial investment spending increase is = $32 / $40 = 0.8

B. Then The multiplier is = 1 / (1 - MPC) is = 1 / (1 - 0.8) = 1 / 0.2 = 5

C. When the same as A and also B, since the question already states that consumption increased by $32 billion in the second round: MPC = 0.8, and also that multiplier is = 5

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