Q1 Consider an economy in which its residents spend 90% of each additional dolla
ID: 1225147 • Letter: Q
Question
Q1
Consider an economy in which its residents spend 90% of each additional dollar they earn and the government increases its spending by $400. Calculate the total effect on output (or aggregate demand)
Q2
The government reduces its spending by $4000 in an economy where households save 25% of each additional dollar they earn.
Calculate the total effect on output (or aggregate demand).
Q3
The government increases taxes by $6200 in an economy where households spend 92% of each additional dollar they earn.
Calculate the total effect on output (or aggregate demand).
Explanation / Answer
(Q1)
Marginal propensity to consume (MPC) = 90% / 100% = 0.9
Spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.9) = 1 / 0.1 = 10
As government spending increases by $1, output increases by $10.
As government spending increases by $400, output increases by $400 x 10 = $4,000
(Q2)
Marginal propensity to save (MPS) = 25% / 100% = 0.25
Spending multiplier = 1 / MPS = 1 / 0.25 = 4
As government spending decreases by $1, output decreases by $4.
As government spending decreases by $4,000, output decreases by $4,000 x 4 = $16,000
NOTE: First 2 questions are answered.
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