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?

Part a: The value of MPC in the economy is 0.6

Part b: The value of Multiplier in the economy is 25.

Part c: The value of Multiplier in the economy is 50.

Explanation:

Part A

The value of MPC is given as

MPC=Change in Consumption/Change in Income

MPC=6/10=0.6

So the value of MPC in the economy is 0.6

Part B

The size of the multiplier is give as

Multiplier=1/(1-MPC)

Multiplier=1/(1-0.6)

Multiplier=1/0.4=25

So the value of Multiplier in the economy is 25.

Part C

The value of multiplier if the consumption and GDP is rose by $8 billion is given as

MPC=Change in Consumption/Change in Income

MPC=8/10=0.8

Multiplier=1/(1-MPC)

Multiplier=1/(1-0.8)

Multiplier=1/0.2=50

So the value of Multiplier in the economy is 50.

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