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?

Question
Asked Oct 15, 2019
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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. 

Instructions: In parts a and b, round your answers to 1 decimal place. In part 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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Expert Answer

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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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