Answered: TOTAL EXPENDITURE (Billions of dollars)…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and total expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph.

The first economy's MPC is 0.5. Therefore, its initial total expenditure line has a slope of 0.5 and passes through the point (100, 100).

The second economy's MPC is 0.70. Therefore, its initial total expenditure line has a slope of 0.70 and passes through the point (100, 100).

Now, suppose there is an increase of $30 billion in investment in each economy.

Place a green line (triangle symbol) on each of the previous graphs to indicate the new total expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output.

MPC=0.70
200
45-Degree Line
180
New AE Line
160
140
120
New Equilibrium
100
80
80
40
AE Line
20
20
40
60
80
100
120 140
160
180
200
REAL GDP (Billions of dollars)
In the first economy (with MPC = 0.5), the $30 billion increase in investment causes equilibrium output to increase by $
billion. In the
second economy (with MPC = 0.70), the $30 billion increase in investment causes equilibrium output to increase by $
billion. Therefore, a
higher MPC is associated with a
v multiplier.
Now, confirm your graphical analysis algebraically using the oversimplified multiplier formula:
Multiplier = 1 MPC
For the first economy, with an MPC of 0.5, the effect of the $30 billion increase in investment is as follows:
TOTAL EXPENDITURE (Billions of dollars)

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