(Simple Spending Multiplier) For each of the following values for the MPC (marginal propensity to
consume), determine the size of the simple spending multiplier and the total change in real GDP
demanded following a $10 billion decrease in spending:
a. MPC = 0.9
b. MPC = 0.75
c. MPC = 0.6
Assume an economy is in recession with a MPC of .75 and there is a GDP gap of $100 billion. How much must government spending increase to eliminate the gap? Instead of increasing govt. spending by the amount that you calculate, what would be the effect of the govt. cutting taxes by this amount?
200 +900
To calculate the size of the simple spending multiplier, we use the formula:
Multiplier = 1 / (1 - MPC).
a. For MPC = 0.9:
Multiplier = 1 / (1 - 0.9) = 1 / 0.1 = 10
b. For MPC = 0.75:
Multiplier = 1 / (1 - 0.75) = 1 / 0.25 = 4
c. For MPC = 0.6:
Multiplier = 1 / (1 - 0.6) = 1 / 0.4 = 2.5
Now, to determine the total change in real GDP demanded following a $10 billion decrease in spending, we multiply the initial change in spending by the spending multiplier.
a. For MPC = 0.9:
Total change in real GDP demanded = $10 billion * 10 = $100 billion
b. For MPC = 0.75:
Total change in real GDP demanded = $10 billion * 4 = $40 billion
c. For MPC = 0.6:
Total change in real GDP demanded = $10 billion * 2.5 = $25 billion
Therefore, the total change in real GDP demanded following a $10 billion decrease in spending would be:
a. For MPC = 0.9: $100 billion
b. For MPC = 0.75: $40 billion
c. For MPC = 0.6: $25 billion
To determine the size of the simple spending multiplier and the total change in real GDP demanded following a $10 billion decrease in spending, we can use the formula:
Simple Spending Multiplier = 1 / (1 - MPC)
Let's calculate the values for each given MPC:
a. MPC = 0.9
Using the formula, the simple spending multiplier is:
1 / (1 - 0.9) = 1 / 0.1 = 10
To calculate the total change in real GDP demanded, we can multiply the spending decrease by the simple spending multiplier:
Total change in real GDP demanded = $10 billion * 10 = $100 billion
b. MPC = 0.75
Using the formula, the simple spending multiplier is:
1 / (1 - 0.75) = 1 / 0.25 = 4
Total change in real GDP demanded = $10 billion * 4 = $40 billion
c. MPC = 0.6
Using the formula, the simple spending multiplier is:
1 / (1 - 0.6) = 1 / 0.4 = 2.5
Total change in real GDP demanded = $10 billion * 2.5 = $25 billion
Therefore, the results are:
a. Simple Spending Multiplier: 10
Total change in real GDP demanded: $100 billion
b. Simple Spending Multiplier: 4
Total change in real GDP demanded: $40 billion
c. Simple Spending Multiplier: 2.5
Total change in real GDP demanded: $25 billion