Chapter 21, Problem 2FRQ

a)

To determine

The size of the change in government purchases that increased real GDP by $200 million when MPC is equal to 0.75.

Explanation of Solution

A change in government purchases will lead to a change in real GDP which would be equal to $200 million where MPC is equal to 0.75

Then,

  $\begin{array}{l}=1/\left(1-MPC\right)\hfill \\ =1/\left(1-0.75\right)\hfill \\ =4\hfill \end{array}$

Now,

  $\begin{array}{l}=200million/4\\ =\$50million\end{array}$

Therefore, the government initially spent $50 million and here the multiplier effect would be raised through GDP by 200 million.

Economics Concept Introduction

Introduction: The marginal propensity to consume refers to the proportion of the amount which is spent on the consumption of goods and services rather than keeping the amount as savings.

The spending multiplier represents the impact of change in autonomous spending on total spending and demand in the economy of the country, which may increase or decrease.

And, a tax multiplier is used to identify the final increase in the level of real GDP with the change in tax rates.

b)

To determine

The value of the spending multiplier would increase real GDP of $200 million when the change in government purchases is $20 million.

Explanation of Solution

When the value of the spending multiplier would lead to an increase in real GDP of $200 million where the government spending on goods and services is changed by $20 million, then the value of this spending multiplier would be:

  $\begin{array}{l}=\$200million/\$20million\hfill \\ =10.\hfill \end{array}$

Therefore, the initial multiplier was 10 in this case.

Economics Concept Introduction

Introduction: The marginal propensity to consume refers to the proportion of the amount which is spent on the consumption of goods and services rather than keeping the amount as savings.

The spending multiplier represents the impact of change in autonomous spending on total spending and demand in the economy of the country, which may increase or decrease.

And, a tax multiplier is used to identify the final increase in the level of real GDP with the change in tax rates.

c)

To determine

The marginal propensity to save would have led to that value of the spending multiplier.

Explanation of Solution

When the marginal propensity to save led to that value of the spending multiplier, then it would be:

1/(1-MPC) = 10

Then, the marginal propensity to save would be 0.9.

Economics Concept Introduction

Introduction: The marginal propensity to consume refers to the proportion of the amount which is spent on the consumption of goods and services rather than keeping the amount as savings.

The spending multiplier represents the impact of change in autonomous spending on total spending and demand in the economy of the country which may increase or decrease.

And, a tax multiplier is used to identify the final increase in the level of real GDP with the change in tax rates.