1. Assume that Carl and Wanda each make $40,000. Each was given a raise of $4,00

Question

1. Assume that Carl and Wanda each make $40,000. Each was given a raise of $4,000. Carl's spending increased from $40,000 to $43,000. Wanda's savings increased from $1,000 to $2,000.

Carl lives in the Macro Islands. What is Carl’s MPC?

Wanda lives in the Micro Islands. What is Wanda’s MPS?

2. When businesses in the Macro Islands increased investment by $30 million to attract tourists, GDP increased by $300 million. Calculate the MPC in the Macro Islands?

3. Assume taxes increase by $300 and government spending increases by $300. The marginal propensity to consume is 0.75. Calculate the total change GDP.

4. If equilibrium output rises by a total of $400 billion in response to an increase in government spending of $80 billion, what is the marginal propensity to consume?

Explanation / Answer

Solution -

1.

Change in Y = 1/(1 – MPC )] * Change in Investment
300 = 1/(1 – MPC )] * 30
(1 – MPC ) = 0.1
MPC = 0.9 .

2.
Change in GDP= ( 1 / (1 - MPC) ) * Change in Government Spending

So, Change in GDP = 1 / 0.25 * 300 = 1200

change in GDP due to Increase in Tax

Change in GDP= [ -b/(1 – b )] * Change in T
Where b = MPC and T = Change in Tax

Change in GDP = [ -0.75 / ( 0.25) ] * 300
= -3 * 300 = -900

Change in Y = 1200-900
= 300

So, GDP increases $300

3.

Change in GDP = [ 1/(1 – MPC )] * Change in Government Spending

400 = [ 1/(1 – MPC )] * 80
[ 1/(1 – MPC )] = 5
MPC = 0.8

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