Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40. The marginal propensity to consume (MPC) for this economy is0.6 , and the spending multiplier for this economy is . Suppose the government in this economy decides to increase government purchases by $400 billion. The increase in government purchases will lead to an increase in income, generating an initial change in consumption equal to . This increases income yet again, causing a second change in consumption equal to . The total change in demand resulting from the initial change in government spending is .

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funmilaciousfunmie78 funmilaciousfunmie78 · Answer 1 · 2020-06-25T02:52:59+02:00

Answer:

The total change in demand resulting from the initial change in government spending is $1,000 billion

Explanation:

Marginal propensity to consume (MPC) = As with every additional increase in income, consumption increases by 0.60.

MPC = change in Consumption / Change in Income = [tex]\Delta C/\Delta Y[/tex]

[tex]\Delta C/\Delta Y[/tex] = 0.60 / 1

MPC = 0.60.

Spending or Expenditure Multiplier = 1 ÷ (1 - MPC)

Spending Multiplier = 1 ÷ (1 - 0.6) = 1 ÷ 0.4 = 2.5.

The consumption will increase by MPC, with 1 dollar increased, consumption increased by 0.60

Therefore, with $400 billion increase, Consumption will increase by 0.60 × 400 billion = $240 billion.

This increases income, causing a change in consumption at second times equal $240 billion × 0.6 = $144 billion.

The total change in income by this increment in government spending equals as:

Change in Demand = Multiplier × change in G

Change in Demand= $400 billion × 2.5 = $1,000 billion.

PiaDeveau PiaDeveau · Answer 2 · 2021-11-26T06:34:05+01:00

The total change in demand resulting from the initial change in government spending is $1,000 billion

Marginal propensity to consume = change in Consumption / Change in Income

Marginal propensity to consume = 0.60 / 1

Marginal propensity to consume = 0.60

Spending Multiplier = 1 / (1 - MPC)

Spending Multiplier = 1 / (1 - 0.6)

Spending Multiplier = 1 / 0.4

Spending Multiplier = 2.5.

Consumption will increase = 0.60 × 400 billion

Consumption will increase = $240 billion.

Consumption will increase second time = $240 billion × 0.6

Consumption will increase second time = $144 billion.

Change in Demand = Multiplier × Spending Multiplier

Change in Demand = $400 billion × 2.5

Change in Demand = $1,000 billion

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