Assume that government purchases decrease by $10 billion, with other factors held constant, including the price level. Calculate the change in the level of real GDP demanded for each of the following values of the MPC.
a. 0.9
b. 0.8
I don't get it ! please help.
0.9=0.1
To calculate the change in the level of real GDP demanded, we need to use the formula for the multiplier effect in the Keynesian model, which is 1/(1- MPC).
MPC stands for Marginal Propensity to Consume, which represents the proportion of an additional dollar of income that is spent on consumption.
a. MPC = 0.9
To calculate the change in real GDP demanded, we substitute the given MPC value into the formula:
Multiplier = 1 / (1 - MPC)
= 1 / (1 - 0.9)
= 1 / 0.1
= 10
The multiplier for an MPC of 0.9 is 10. This means that for every $1 decrease in government purchases, the level of real GDP demanded will decrease by $10.
b. MPC = 0.8
Similarly, for an MPC of 0.8:
Multiplier = 1 / (1 - MPC)
= 1 / (1 - 0.8)
= 1 / 0.2
= 5
The multiplier for an MPC of 0.8 is 5. This means that for every $1 decrease in government purchases, the level of real GDP demanded will decrease by $5.
So, a decrease of $10 billion in government purchases, with an MPC of 0.9, will result in a decrease in the level of real GDP demanded by $100 billion (10 x $10 billion). With an MPC of 0.8, the decrease in the level of real GDP demanded would be $50 billion (5 x $10 billion).