Suppose that the marginal propensity to consume in an economy is equal to 0.80 a

Question

Suppose that the marginal propensity to consume in an economy is equal to 0.80 and that you are told that investment spending decreases this year by $100. You are asked to calculate the change in consumer spending for the second, third and fourth rounds. In addition you are asked to calculate the change in real income due to this change in investment spending. Assume that in this economy there is no government sector, no taxes (ha ha ha), no transfers (no welfare), and that the aggregate price level and interest rate are fixed.

Step 1: Create a table to record the change in spending for each round as well as the initial impact of the change in investment spending. 15 POINTS

Step 2: Calculate the total increase in real GDP.

Explanation / Answer

C=Co +bY

Y=C+I

where Co=autonomous consumption

b=marginal propensity to consume

I=investment spending

Y=Co+0.8Y+I

0.2Y=Co+I

since, Co does not change

hence change in GDP=change in I/0.2

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