Question

2A.      Using the “Keynesian Cross” logic of Chapter 11, suppose that Government spending increases by $10. The marginal propensity to consume is 0.90. How much, overall, would incomes (Y) increase by? Explain your answer or show the equation(s) you used.

B.        How much would consumption spending and private (household) savings change by?

HINT—In part A, you found the change in Y. Combining the change in Y with the MPC might be useful.

C.        Suppose now that Investment spending increased by $10 instead. Again using the Keynesian Cross logic with an MPC of 0.90, how much would incomes (Y) rise by?

Answer 1

Question 2

(A)

Increase in government spending = $10

Marginal propensity to consume (MPC) = 0.9

Calculate the value of the multiplier -

Multiplier = 1/(1 - MPC)

Multiplier = 1/(1 - 0.9)

Multiplier = 1/0.10 = 10

The value of multiplier is 10.

Calculate the increase in income (Y) -

Increase in income = Increase in government spending * Multiplier

Increase in income = $10 * 10 = $100

Thus,

The overall increase in income (Y) would be $100.

(B)

Increase in income = $100

MPC = 0.9

Calculate the change in consumption spending -

Increase in consumption spending = Increase in income * MPC

Increase in consumption spending = $100 * 0.9 = $90

Thus,

The consumption spending would increase by $90.

Calculate the increase in private (household) savings -

Increase in private savings = Increase in income - Increase in consumption = $100 - $90 = $10

Thus,

The increase in private (household) savings is $10.

(C)

Increase in investment spending = $10

Marginal propensity to consume (MPC) = 0.9

Calculate the value of the multiplier -

Multiplier = 1/(1 - MPC)

Multiplier = 1/(1 - 0.9)

Multiplier = 1/0.10 = 10

The value of multiplier is 10.

Calculate the increase in income (Y) -

Increase in income = Increase in investment spending * Multiplier

Increase in income = $10 * 10 = $100

Thus,

The income (Y) would rise by $100.