Chapter 16, Problem 2CYU

To determine

The question requires us to determine the value of the spending multiplier when mpc is 0.5 and 0.8.

Explanation of Solution

a) When MPC is 0.5

Spending multiplier is:

  $\begin{array}{c}\frac{\text{ΔY}}{\text{ΔAS}}\text{=}\frac{\text{1}}{\text{1-MPC}}\\ \text{=}\frac{\text{1}}{\text{1-0}\text{.5}}\\ \text{=}\frac{\text{1}}{\text{0}\text{.5}}\\ \text{=2}\end{array}$

Therefore, the value of the spending multiplier is 2.

b) When MPC is 0.8

Spending multiplier is:

  $\begin{array}{c}\frac{\text{ΔY}}{\text{ΔAS}}\text{=}\frac{\text{1}}{\text{1-MPC}}\\ \text{=}\frac{\text{1}}{\text{1-0}\text{.8}}\\ \text{=}\frac{\text{1}}{\text{0}\text{.2}}\\ \text{=5}\end{array}$

Therefore, the value of the spending multiplier is 5.

Economics Concept Introduction

The spending multiplier shows the impact of change in aggregate spending on the real GDP. The expression for spending multiplier is the following:

  $\frac{\text{ΔY}}{\text{ΔAS}}\text{=}\frac{\text{1}}{\text{1-MPC}}$