Question

1. What is the multiplier if the marginal propensity to consume (MPC) is 0.5? Calculate the marginal propensity to save (MPS)?

2. What is the multiplier if the MPS is 0.2? Calculate the MPC.

3. As a percentage of GDP, savings accounts for a larger share of the economy in the country of Scania compared to the country of Amerigo. Which country is likely to have the larger multiplier? Explain.

4. Assuming that the aggregate price level is constant, the interest rate is fixed, and there are no taxes and no foreign trade, what will be the change in GDP if the following events occur?

a. There is an autonomous increase in consumer spending of $25 billion; the marginal propensity to consume is 2/3.

b. Firms reduce investment spending by $40 billion; the marginal propensity to consume is 0.8.

c. The government increases its purchases of military equipment by $60 billion; the marginal propensity to consume is 0.6.

5. The Bureau of Economic Analysis reported that, in real terms, overall consumer spending increased by $66.2 billion during the second quarter of 2014.

a. If the marginal propensity to consume is 0.52, by how much will real GDP change in response?

b. If there are no other changes to autonomous spending other than the increase in consumer spending in part a, and unplanned inventory investment, Iunplanned decreased by $50 billion, what is the change in real GDP?

c. GDP at the end of the first quarter in 2014 was $16,014.10 billion. If GDP were to increase by the amount calculated in part b, what would be the percent increase in GDP?

Answer 1

Value of multiplier= 1/(1-MPC)

= 1/(1-0.5)

=1/0.5

=2

MPS= 1- MPC
= 1- 0.5

= 0.5

 

2.

Value of multiplier= 1/(1-MPC)

OR 1/ MPS

= 1/0.2

= 5

MPC= 1- MPS
= 1-0.2

= 0.8

 

3.

Amerigo is expected to have larger multiplier than Scania. This is because marginal propensity to save (MPS) is lower in Amerigo which implies marginal propensity to consume is higher (MPC). Greater is the marginal propensity to consume, more is the value of multiplier. Higher spending means more fundsare available in next round of. Thus, less disposable income “leaks out” in form of savings at each round of expansion.

 

4.

a.

 

Multiplier = 1/1-MPC

=1/1-2/3

=1/1/3

= 3

Change in GDP= Increase in autonomous consumer spending* Value of multiplier

= $ 25 billion * 3

= $75 billion

Thus, GDP will increase by $75 billion.

 

b.

Value of multiplier = (1 / (1 - MPC))
= (1 / (1 – 0.8)

= 5

Change in GDP = Value of multiplier* change in Investment (I)

= 5 * (-$40 billion)

= - $200 billion

Thus, GDP will fall by 200 billion

 

c.

Value of multiplier = (1 / (1 - MPC))
= (1 / (1 – 0.6)

= 1/0.4

= 2.5

Change in GDP = Value of multiplier* change in Government spending (G)

= 2.5* 60 billion

= $150 billion

Thus, GDP will increase by $150 billion

5.

a.

Multiplier= 1/1-MPC

= 1/1-0.52

=1/0.48

= 2.083

Change in GDP = Value of multiplier* Increase in Consumer spending

=2.083* $66.2 bn

= $137.91 bn (Increase in GDP)

 

b.

When planned aggregate spending is larger than equilibrium level, unplanned inventory investment turns negative. Real GDP is equal to C + I (planned).Thus, any unplanned reduction of inventories will have direct effect on GDP and the GDP will decrease by 50 billion.

Thus, the net effect will be 137.91 bn- 50 bn

= $87.91 bn

c.

Percent increase in GDP= Increase in GDP/GDP in quarter 1

= $87.91 bn /$16014.1 bn

= 0.548 %

Skill Required:

Accounting

Question Price:

0 PKR

Answer Submitted:

11 months ago