Question

a. Assume that Ajani did not buy a $30,000 car from Humbug because of the unexpected tax bill. If the MPC is .6, how much will Humbug reduce his spending from Tanaka?

b. Humbug’s drop in spending causes a chain reaction which is illustrative of the multiplier effect. Assuming that each person in the chain spends sixty percent of any change in income on the person next in the chain, how much would Gonzales’ income be reduced by Ajani’s cancelled $30,000 car purchase?

Answer 1

(a)

If Ajani bought the $30,000 car from Humbug then Humbug would have got the income of $30,000.

The MPC is 0.6

This means Humbug would have spend 60% of this income.

So,

Spending of Humbug = Income * MPC = $30,000 * 0.6 = $18,000

The Humbug would have spend $18,000.

So,

If Ajani did not buy a $30,000 car from Humbug then Humbug would reduce his spending by $18,000 from Tanaka.

(b)

If Ajani bought the $30,000 car from Humbug then Humbug would have got the income of $30,000.

The MPC is 0.6

This means Humbug would have spend 60% of this income.

So,

Spending of Humbug = Income * MPC = $30,000 * 0.6 = $18,000

The Humbug would have spend $18,000.

Humbug would have spend the $18,000 on Landscaping by Tanaka.

So, Tanaka would have got income of $18,000.

MPC = 0.6

Spending by Tanaka = $18,000 * 0.6 = $10,800

The Tanaka would have spend $10,800.

Tanaka would have spend the money on purchase of new TV from Goldman.

So, Goldman would have got income of $10,800.

MPC = 0.6

Spending by Goldman = $10,800 * 0.6 = $6,480

The Goldman would have spend $6,480.

Goldman would have spent money on tour arranged by Travel agent Gonzalez.

So, Gonzalez would have got income of $6,480.

Thus,

The Gonzalez's income would have been decreased by $6,480 due to Ajani's cancelled $30,000 car purchase.