Due to an increase in consumer wealth, there is a $40 billion autonomous increas
ID: 2496097 • Letter: D
Question
Due to an increase in consumer wealth, there is a $40 billion autonomous increase in consumer spending in the economies of Westlandia and Eastlandia. Assuming that the aggregate price level is constant, the interest rate is fixed in both countries, and there are no taxes and no foreign trade, complete the accompanying tables to show the various rounds of increased spending that will occur in both economies if the marginal propensity to consume is 0.5 in Westlandia and 0.75 in Eastlandia. What do your results indicate about the relationship between the size of the marginal propensity to consume and the multiplier? Incremental Total change change Rounds in GDP in GDP 1 C = $40 billion ? 2 MPC × C = ? ? 3 MPC × MPC × C = ? ? 4 MPC × MPC × MPC × C = ? ? . . . . . . . . . Total change in GDP (1/(1 MPC)) C ? Eastlandia Incremental Total change change Rounds in GDP in GDP 1 C = $40 billion ? 2 MPC × C = ? ? 3 MPC × MPC × C = ? ? 4 MPC × MPC × MPC × C = ? ? . . . . . . . . . Total change (1/(1 MPC)) C ?
Explanation / Answer
Following is the complete table –
Economy of Westlandia –
Rounds
Incremental change in GDP
Total change in GDP
1
C = $40 billion
$40 billion
2
MPC*C = 0.5*$40 billion = $20billion
$40 billion+$20 billion = $60 billion
3
MPC*MPC*C = 0.5*0.5*$40 billion = $10 billion
$60 billion+$10 billion = $70 billion
4
MPC*MPC*MPC*C = 0.5*0.5*0.5*$40 billion = $5 billion
$70 billion + $5 billion = $75 billion
Total change in GDP = (1/1-MPC) * C
= (1/1-0.5) * $40 billion
= 2 * $40 billion
= $80 billion
The total change in GDP is $80 billion.
Following is the complete table –
Economy of Eastlandia –
Rounds
Incremental change in GDP
Total change in GDP
1
C = $40 billion
$40 billion
2
MPC*C = 0.75*$40 billion = $30billion
$40 billion+$30 billion = $70 billion
3
MPC*MPC*C = 0.75*0.75*$40 billion = $22.5 billion
$70 billion+$22.5 billion = $92.5 billion
4
MPC*MPC*MPC*C = 0.75*0.75*0.75*$40 billion = $16.9875 billion
$92.5 billion + $16.9875 billion = $109.4875 billion
Total change in GDP = (1/1-MPC) * C
= (1/1-0.75) * $40 billion
= 4 * $40 billion
= $160 billion
The total change in GDP is $160 billion.
The value of marginal propensity to consume in case of Westlandia is 0.5 and the value of multiplier (1/1-MPC) is 2.
On the other hand, the value of marginal propensity to consume in case of Eastlandia is 0.75 and the value of multiplier (1/1-MPC) is 4.
The above assertions state the relationship between marginal propensity to consume and multiplier that is higher the value of marginal propensity of consume, higher will be the value of multiplier and vice-versa.
Rounds
Incremental change in GDP
Total change in GDP
1
C = $40 billion
$40 billion
2
MPC*C = 0.5*$40 billion = $20billion
$40 billion+$20 billion = $60 billion
3
MPC*MPC*C = 0.5*0.5*$40 billion = $10 billion
$60 billion+$10 billion = $70 billion
4
MPC*MPC*MPC*C = 0.5*0.5*0.5*$40 billion = $5 billion
$70 billion + $5 billion = $75 billion
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