Question

Consider a hypothetical closed economy in which households spend $0.75 of each additional dollar they earn and save the remaining $0.25.

The marginal propensity to consume (MPC) for this economy is ___(0.25 / 0.75 / 1 / 1.33 / 4)___ , and the spending multiplier for this economy is ____(0.25 / 0.75 / 1 / 1.33 / 4)____ .

Suppose the government in this economy decides to decrease government purchases by $250 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to ____(-1,000billion / -500billion / -187.5billion / -93.8billion / -62.5billion)___ . This decreases income yet again, causing a second change in consumption equal to ___(-1000billion / -500billion / -93.8billion / -140.6billion / -62.5billion)____ . The total change in demand resulting from the initial change in government spending is .

Answer 1

Answer and Explanation:

According to the scenario, computation of the given data are as follow:-

1) Marginal propensity to consume (MPC) for this economy is 0.75 as it denotes the spending of the household and saving of 0.25 and the spending multiplier for this economy is

= Spending Multiplier(M)

= 1 ÷ 1 - MPC

= 1 ÷ 1-0.75

= 1 ÷ 0.25

= 4

2). Decrease in government purchases will lead to a decrease in income, generating an initial change in consumption

= -Amount of Government Decrease Purchases by × MPC

= -$250 billion × 0.75

= -$187.5 billion

3). Decrease income again, causing a second change in consumption

= Amount Decrease in Government Purchases × MPC

= -$187.5 billion × 0.75

= $140.6 billion

4).Total change in demand resulting from the initial change in government spending

=  Amount of Government Decrease Purchases by × Spending Multiplier(M)  

= $250 × 4

= $1,000 billion

= $1 trillion

As we can see that the income falls by $1000 billion in the end, so AD shifts to the left by the size of $1 trillion

In the question the graph is missing. Kindly find the attachment for both of question and answer

Answer 2

Each additional dollar costs a households $0.75. MPC equals 0.75 in this case.

1). This country's economic marginal propensity is 0.75, indicating household consumption of 0.25 and conserving of 0.25, and the spending multiplier is 0.25.

Spending Multiplier = 1 / (1 - MPC)

Spending Multiplier = 1 / (1 - 0.75)

Spending Multiplier = 1 / 0.25  

Spending Multiplier = 4

2). Reduced government purchases will result in lower revenue, causing an initial shift in expenditure.

Purchases by the government have decreased by a significant amount. × MPC  

$250 billion × 0.75

$187.5 billion

3). Reduce income once again, generating a second shift in consumption.

Government Purchases Decreased by a Certain Amount × MPC  

$187.5 billion × 0.75

$140.6 billion

4).Quantity demanded change as a result of the first shift in government spending  

Acquisitions by the government have decreased by a significant amount.× Spending Multiplier  

$250 × 4

$1,000 billion

$1 trillion

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