Chapter 13, Problem 5P

To determine

Concept Introduction:

Marginal Propensity to Consume ( MPC ):

It overall raise is that proportion of amount which the consumer pay for consumption of goods and services, and it does not include the savings of the consumer.

Effect on government spending, consumption spending, gross domestic product and disposable income in each case.

Explanation of Solution

a.

Given,

MPC is 0.6.

Formula to calculate change in consumption is,

Change in consumption in round three,

Similarly further change in consumption will be calculated in the table.

Formula to calculate change in real GDP is,

With $10 billion reduction in government purchases:

Rounds	Change in G or C (billions of dollar)	Change in real GDP(billions of dollar)	Change in YD (billions of dollar)
1		-10	-10
2		-6	-6
3		-3.60	-3.60
4		-2.16	-2.16
5		-1.30	-1.30
6		-0.78	-0.78
7		-0.47	-0.47
8		-0.28	-0.28
9		-0.17	-0.17
10		-0.10	-0.10
Total		-24.86
Table(1)

b.

With decrease in government transfers:

Rounds	Change in TR or C (billions of dollar)	Change in real GDP(billions of dollar)	Change in YD (billions of dollar)
1		0	-10
2		-6	-6
3		-3.60	-3.60
4		-2.16	-2.16
5		-1.30	-1.30
6		-0.78	-0.78
7		-0.47	-0.47
8		-0.28	-0.28
9		-0.17	-0.17
10		-0.10	-0.10
Total		-14.86
Table(2)

c.

Given,

MPC is 0.6.

Change in real GDP when there is decrease in government spending:

Formula to calculate change in real GDP when there is decrease in government spending is,

(I)

Substitute 0.6 for MPC and -$10 billion for change in spending in equation (I).

Change in real GDP when there is decrease in government transfers:

Formula to calculate change in real GDP when there is decrease in government transfers is,

Substitute 0.6 for MPC and -$10 billion for change in spending in equation (I).

There is no change in real GDP in the first round so the difference in change in real GDP will be -$10 billion.

Formula to calculate difference between the two GDP is,

Substitute -$25 for change in real GDP when government reduces spending and -$15 billion for change in real GDP when government transfers falls.