Consider a hypothetical closed economy in which households spend $0.70 of each a
ID: 1202520 • Letter: C
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
A).3
B).7
C) 1
D) 1.43
E) 3.33
and the oversimplified multiplier for this economy is
A).3
B).7
C) 1
D) 1.43
E) 3.33
Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to
A) -$1,000 billion
B) -$90 billion
C) -$210 billion
D )-$500 billion
E) -$105 billion
This decreases income yet again, causing a second change in consumption equal to
A)-$1,000 billion
B) -$90 billion
C) -$210 billion
D) -$500 billion
E) -$107 billion
The total change in demand resulting from the initial change in government spending is
A)-$0.6 trillion
B) -$0.7 trillion
C) -$2.7 trillion
D)-$1 trillion
Explanation / Answer
1. The marginal propensity to consume (MPC) for this economy is: 0.7
2. and the oversimplified multiplier for this economy is: 3.33 (i.e. 1/1-mpc)
3. Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to: -$210 billion (i.e. $300 * 0.7)
4. This decreases income yet again, causing a second change in consumption equal to: -$147 billion (i.e. $210 * 0.7). Note:This answer is not in the option
5. The total change in demand resulting from the initial change in government spending is: -$1 trillion (i.e. $300 * 3.33)
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