How much of a change in the economy will result if business increase their level of investment by $8 billion and the MPC in the economy is 4/5? If the MPC is 2/3?
To determine the change in the economy resulting from an increase in business investment, we can use the formula for the multiplier effect, which is equal to 1 divided by the marginal propensity to consume (MPC).
The MPC represents the proportion of each additional dollar of income that is spent on consumption. For example, an MPC of 4/5 means that 4/5 or 80% of each additional dollar earned will be spent on consumption.
To calculate the multiplier effect, we use the formula: multiplier = 1 / (1 - MPC)
1. If the MPC is 4/5:
multiplier = 1 / (1 - 4/5) = 1 / (1/5) = 5
With a multiplier of 5, we can calculate the change in the economy by multiplying the increase in investment by the multiplier:
change in the economy = $8 billion * 5 = $40 billion
Therefore, if businesses increase their level of investment by $8 billion, and the MPC in the economy is 4/5, the change in the economy would be an increase of $40 billion.
2. If the MPC is 2/3:
multiplier = 1 / (1 - 2/3) = 1 / (1/3) = 3
Using the same calculation as before:
change in the economy = $8 billion * 3 = $24 billion
Therefore, if businesses increase their level of investment by $8 billion, and the MPC in the economy is 2/3, the change in the economy would be an increase of $24 billion.