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3. The more important question concerns the cumulative effect of an initial change in autonomous spending, such as your rich aunt's one-time gift, after several months. When income is spent, this spending becomes someone else's income and so on. We define the economic impact after n months to be the total amount of money that is spent and returned to the economy after n months. For the case of the $10,000 gift, explain why the economic impact after n months is given by the sum I(n) = $10, 000 (0.95)*. k=0

3. The more important question concerns the cumulative effect of an initial change in autonomous spending, such as your rich aunt's one-time gift, after several months. When income is spent, this spending becomes someone else's income and so on. We define the economic impact after n months to be the total amount of money that is spent and returned to the economy after n months. For the case of the $10,000 gift, explain why the economic impact after n months is given by the sum I(n) = $10, 000 (0.95)*. k=0

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Suppose that one day your rich aunt unexpectedly gives you $10,000 to use as you like, no strings attached. A fraction of that gift will be consumed (the marginal propensity to consume, MPC) or saved (the marginal propensity to save, MPS). If you are like the "average American," you will save less than 5% of your $10,0002. The money you don't save is consumed and is spent on purchasing goods and services. So, whether you spend the increased income on food, entertainment, paying off loans, or a new bicycle, that money goes back into the economy, where it generates revenue through taxes, and gets spent again. This is because an injection of extra income leads to more spending, which creates more income, and so on. In this way, your money is actually spent many times and it has the effect of stimulating the economy through what is known as the multiplier effect. Gifts from rich aunts are not the only way to stimulate the economy. Governments occasionally provide an economic stimulus by increasing their spending or by offering tax rebates or refunds that have similar effects. Economic systems are incredibly complex and difficult to model. In this project we look at a simplified explanation of how the multiplier effect leads to economic growth. (It is worth noting that some economists view the Keynesian economic principles upon which this project is based with deep suspicion; these economists believe government stimulus spending does not work as advertised.)
Transcribed Image Text:Suppose that one day your rich aunt unexpectedly gives you $10,000 to use as you like, no strings attached. A fraction of that gift will be consumed (the marginal propensity to consume, MPC) or saved (the marginal propensity to save, MPS). If you are like the "average American," you will save less than 5% of your $10,0002. The money you don't save is consumed and is spent on purchasing goods and services. So, whether you spend the increased income on food, entertainment, paying off loans, or a new bicycle, that money goes back into the economy, where it generates revenue through taxes, and gets spent again. This is because an injection of extra income leads to more spending, which creates more income, and so on. In this way, your money is actually spent many times and it has the effect of stimulating the economy through what is known as the multiplier effect. Gifts from rich aunts are not the only way to stimulate the economy. Governments occasionally provide an economic stimulus by increasing their spending or by offering tax rebates or refunds that have similar effects. Economic systems are incredibly complex and difficult to model. In this project we look at a simplified explanation of how the multiplier effect leads to economic growth. (It is worth noting that some economists view the Keynesian economic principles upon which this project is based with deep suspicion; these economists believe government stimulus spending does not work as advertised.)
3. The more important question concerns the cumulative effect of an initial change in autonomous spending, such as your rich aunt's one-time gift, after several months. When income is spent, this spending becomes someone else's income and so on. months to be the total amount of money that is spent and returned to the economy after n months. For the case of the $10,000 gift, explain why the economic impact after n months is given by the sum We define the economic impact after n n I(n) = $10, 000 (0.95)*. %3D k=0
Transcribed Image Text:3. The more important question concerns the cumulative effect of an initial change in autonomous spending, such as your rich aunt's one-time gift, after several months. When income is spent, this spending becomes someone else's income and so on. months to be the total amount of money that is spent and returned to the economy after n months. For the case of the $10,000 gift, explain why the economic impact after n months is given by the sum We define the economic impact after n n I(n) = $10, 000 (0.95)*. %3D k=0
Expert Solution
Step 1

The Keynesian cross model says,

Y=C+I+GC=a+cY

where C, I and G are consumption , investment and Government spending respectively. a is the autonomous consumption and c is the marginal propensity to consume, in this problem c=0.95.

So when income goes up by a dollar, consumption goes up by c dollars which again increases the income by c dollars. A c dollar increase in income causes consumption to go up by c2 dollars which again increase the income by the same amount.

 

 

 

 

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