The value of the marginal propensity to save is 0.2. If real GDP increases by $50 billion, this situation was the result of an increase in the aggregate expenditures schedule of:
a. $10 billion
b. $15 billion
c. $16 billion
d. $40 billion
Take a shot. Hint, calculate a multiplier.
a.$10 billion
To solve this question, we need to understand the concept of the marginal propensity to save (MPS) and the multiplier effect.
The MPS is the fraction of additional income that individuals choose to save rather than spend. In this case, the value of the MPS is given as 0.2, which means that for every additional dollar of income, individuals save $0.20 and spend $0.80.
The multiplier effect is the phenomenon that occurs when an increase in autonomous spending (aggregate expenditures) leads to a larger increase in real GDP. The multiplier is calculated using the formula: multiplier = 1 / (1 - MPS).
In this case, we are given that real GDP increased by $50 billion. To determine the increase in aggregate expenditures, we need to find the initial change in spending that caused this increase.
To do that, we can use the multiplier: multiplier = 1 / (1 - MPS) = 1 / (1 - 0.2) = 1 / 0.8 = 1.25.
Now, we can calculate the initial change in aggregate expenditures by dividing the increase in real GDP by the multiplier: initial change in expenditures = increase in real GDP / multiplier = $50 billion / 1.25 = $40 billion.
Therefore, the correct answer is (d) $40 billion. The situation was the result of an increase in the aggregate expenditures schedule of $40 billion.
Remember, the multiplier effect allows you to calculate the initial change in aggregate expenditures given an increase or decrease in real GDP and the value of the MPS.