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Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion. a. If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume ( MPC ) to be? b. Now suppose the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?
Principles of Macroeconomics (Mind...
Principles of Macroeconomics (Mind...
Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion.
a. If these economists ignore the possibility of crowding out, what would they estimate the marginal propensity to consume (MPC) to be?
b. Now suppose the economists allow for crowding out. Would their new estimate of the MPC be larger or smaller than their initial one?
Subpart (a):
Explanation of Solution
When there is no crowding out effect, the multiplier is calculated using the following equation:
Since the multiplier is 3, the marginal propensity to consume is calculated using equation 1, as follows:
Subpart (b):
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