Consider a hypothetical closed economy in which households spend $0.70 of each a

Question

Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30 The marginal propensity to consume (MPC) for this economy is and the spending multiplier for this economy is Suppose the government in this economy decides to increase government purchases by $300 billion. The increase in government purchases will lead to an increase in income, generating an initial change in consumption equal to second change in consumption equal to " This increases income yet again, causing a The total change in demand resulting from the initial change in government spending is

Explanation / Answer

1. MPC = 0.7

Spending multiplier = 1/(1-MPVC) = 1/(1-0.7) = 3.33

2. Initial change in consumption = 0.7(300) = $210

Second change in consumption = 0.7(210) = $147

Total increase in income = 300(3.33) = $1000

3. AD curve will shift outside parallely to right.

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