Question

8. This question has to do with calculating the multiplier. Please answer questions 8a through 8c below.

  8a. Define and write the formula for the multiplier.

8b. Compute the multiplier if the MPC=0.3. Interpret the multiplier you just calculated.

8c. An Economist estimates that the MPC is now 0.7 because he received information that a company like GM are very optimistic about the future sales of their cars and trucks, so an economic expansion is inevitable. Calculate the new multiplier. Interpret the new multiplier you just calculated. Did the multiplier get smaller or bigger when the MPC rises to 0.60? Why? What does this do to consumption and investment for cars and trucks and other goods produced and bought in the U.S. economy? Is an economic expansion possible if the MPC had risen from 0.3 to 0.7? Does disposable income fall or rise when MPC rises from 0.3 to 0.7? Explain. Calculate the new multiplier and compare it with the multiplier you just calculated in 9b and then explain your results.

Note: Please label your graphs and axes on graph problems and please show your work and calculations and your steps on the math problems.

Answer 1

8. a. The formula for multiplier is given as: 1÷(1-MPC).

In other words, multiplier shows how many times the income is going to increase due to the increase in investment. This depends on the marginal propensity to consume. This is because when an investment increases, the amount of income increase will depend on how much part of the income is consumed by the individuals.

b. When MPC = 0.3 => Multiplier= 1/1-0.3 = 1/0.7 = 1.43.

This says that when people only spend 30% of income on consumption, the income will grow 1.43 times more than the amount of investment.

When MPC = 0.7, New multiplier = 1/ (1-0.7) = 1/0.3 = 3.33

This says that when 30% of income is spent on consumption, the income will grow 3.33 times more than the investment.

When mpc rises from 0.3 to 0.7, it means that people are consuming a significant proportion of their income levels. This means that there is a significant demand for the goods like cars and trucks in the economy and there is an economic expansion as the income is growing more times as compered to the multiplier when mpc was low or only 0.3 . Since more income is generated when the mpc rises from 0.3 to 0.7, the disposable incomes increase.