Question

69. The greater the marginal propensity to import:

a. the smaller the spending multiplier.

b. the greater the level of investment.

c. the greater is the net export.

d. the smaller is the level of consumption.

Please give the answer and explain.

Answer 1

Marginal propensity to import shows the change in import demand due to marginal change in income. As domestic income rises, a higher marginal propensity to import implies that a higher part of the increase in income will be spent on import demand. This rise in import demand will lead to higher output for the foreign country and not for the domestic country. Hence a higher marginal propensity to import means the smaller the spending multiplier.

Spending multiplier without taxes =1/(1-MPC+MPI). As can be seen from this formula, a higher maginal propensity to import (MPI) will reduce spending multipier.