An economy has a marginal propensity to consume of 0.6, real GDP equals $500 bil

Question

An economy has a marginal propensity to consume of 0.6, real GDP equals $500 billion, and the government collects 20% of GDP in taxes. If government purchasesincrease by $10 billion, show the rounds of increased spending that take place by completing the accompanying table. The first and second rows are filled in for you.

In the first row, the increase in government purchases of $10 billion raises real GDP by $10 billion, taxes increase by $2 billion, and DI increases by $8 billion; in the second row, the increase in

DI of $8 billion increases consumer spending by $4.80 billion (MPC×change in disposable income).

a.

What is the total change in real GDP after the 5 rounds? What is the value of

the multiplier? What is the eventual change in GDP after it reaches equilibrium?

Change in or Change in real GDP Change in taxes Change in YD Rounds (billions dfbdbkaspf dollars) $10.00 4.80 2.30 1.10 0.53 0.25 0.12 0.06 0.03 0.01 $2.00 0.96 0.46 0.22 0.11 0.05 0.02 0.01 0.01 0.00 $8.00 3.84 1.84 0.88 0.42 0.20 0.10 0.05 0.02 0.01 AG-$10.00 = 4.80 = 2.30 C = 1.10 C = 0.53 = 0.25 C = 0.12 C = 0.06 = 0.03 AC 0.01 4 10 Sum for 10 rounds $19.20

Explanation / Answer

After 5 rounds of increased spending, the total increase in GDP = 10 + 4.8 + 2.3 + 1.10 + 0.53 = $18.73

Multiplier = 1/1-MPC

M= 1/1-0.6

M = 1/0.4

M = 5/2 or 2.5

Eventually, taking multiplier effect into consideration, the initial change in $10 billion = 5/2 * 10 = $25 billion.

Total increase in GDP = 500 + 25 = $525 billion. The GDP would increase with this increase in government spending.

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