# Suppose that an initial \$ 10 billion increase in investment spending expands GDP by \$ 10 billion in the first round of the multiplier process. Also suppose that GDP and consumption both rise by \$ 6 billion in the second round of the process. Instructions: In parts a and b, round your answers to 1 decimal place. In part c enter your answer as a whole number. A) What is the MPC in this economy? B) What is the size of the multiplier? C) If, instead, GDP and consumption both rose by \$ 8 billion in the second round, what would have been the size of the multiplier?

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Suppose that an initial \$ 10 billion increase in investment spending expands GDP by \$ 10 billion in the first round of the multiplier process. Also suppose that GDP and consumption both rise by \$ 6 billion in the second round of the process.

A) What is the MPC in this economy?

B) What is the size of the multiplier?

C) If, instead, GDP and consumption both rose by \$ 8 billion in the second round, what would have been the size of the multiplier?

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Step 1

Given:

Change in consumption = \$6 billion

Change in income = \$10 billion

(We know, GDP = C + I + G + (X-M)

Where, C= consumption, I= investment, G= government expenditure and X-M= net exports

Therefore, change in Investment by \$10B means GDP automatically increases by \$10B. Similarly, change in Consumption by \$6B means GDP automatically increases by \$6B.)

a) The formula used to find MPC:

MPC = Change in consumption / Change in income

MPC = 6/10 = 0.6

Therefore MPC = 0.6

Step 2

b)

Formula to find multiplier (k) = 1/(1-MPC)

k= 1/1-0.6 = 2.5...

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