Question

During a recession, the government spends $100 million to stimulate the economy. If the marginal propensity to consume is 0.8, what will be the potential increase in income in the economy as a result of the government’s increase in the spending level?

A) $100 million

B) $125 million

C) $500 million

D) $80 million

Answer 1

C) $500 Million

(We can use the concept of Multiplier to find the potential Increase in income.

>For that, following formula can be used.

Increase in income = Kg * ∆ G

Kg. = Government Expenditure Multiplier

∆ G = government Expenditure or the amount spend by the government to stimulate the economy * multiplier

= 100 million

> In order to use this formula, we need the value of Multiplier

Kg = 1/1-mpc

=1/1-0.8

=1/0.2

= 5

>Now,we can find the Increase in income.

Increase in income= 100 million * 5

= 500 million)