In order to financially stimulate the nation, the Federal government injected $9

Question

In order to financially stimulate the nation, the Federal government injected $900 billion dollars into the economy. However, the results were less than spectacular. One reason could have been a failure to understand the marginal propensity to consume. Assume the marginal propensity to consume (MPC) was only 0.4. How much of that $900 billion went to increased consumption? Where did the rest of the money go?

Increased consumption: ________________________

Where did the rest go? _________________________

Using MPC = 0.4, what is the spending multiplier (the actual numerical value please):

___________________

What was the overall change in income as a result of the stimulus package after the multiplier completely works its way through the economy?

__________________

Explanation / Answer

Given the MPC = 0.4 , an increase in money supply by $900 billion would induce 0.4 * 900 = $360 increase in consumption.

The rest of the money ( 900 - 360 ) = $540 is saved by the people.

Spending multiplier = 1/(1 - MPC)

= 1/(1 - 0.4) = 1/0.6 = 10/6 = 1.66

Thus the change in overall income in the economy would be= multiplier * 900 = 900* 1.66 = $1494

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