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...

7th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781285165912

Chapter
Section

Principles of Macroeconomics (Mind...

7th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781285165912
Chapter 21, Problem 7PA
Textbook Problem
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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?

Subpart (a):

To determine
Marginal propensity to consume.

Explanation of Solution

When there is no crowding out effect, the multiplier is calculated using the following equation:

Multiplier=11MPC (1)

Since the multiplier is 3, the marginal propensity to consume is calculated using equation 1, as follows:

1MPC=1

Subpart (b):

To determine
Marginal propensity to consume.

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