Question

1. Explain with (2-3 sentences) whether each of the following would cause the value of the multiplier to be larger or smaller.

   1. An increase in real GDP increases imports

   2. An increase in real GDP increases interest rates

   3. An increase in real GDP increases MPC

   4. An increase in real GDP causes the average tax rate paid by households to decrease

   5. An increase in real GDP increases the price level

Answer 1

1) An increase in imports will reduce spending of domestic goods. Assume MPC = 0.8, increase in imports will reduce domestic MPC as MPC = MPC Domestic + MPC from Imports

A fall in MPC Domestic from rise in imports will reduce the multiplier in the economy.

k = [1 / (1 - MPC Domestic)]

2) Increase in real GDP increases rate of interest does not effect multiplier.

3) Increase in real GDP increases MPC will effect multiplier as spending multiplier is [1 / (1 - MPC)]. An increase in MPC will raise consumption by consumers which will raise circulation of money. Spending of money by one consumer will raise income for others which raise consumers by everyone.

4) Increase in real GDP raise the average tax rate will affect multiplier as tax multiplier is calculated as [MPC / (1 - MPC)]. This multiplier would be less than total spending multiplier as there is decrease in consumer disposable income after paying taxes wich reduces consumption in economy.

5) Increase in real GDP raise the price level does not affect multiplier.