Question

These equations represent the AE model of Country X and correspond with Question #1

C = 0.75(DI) + 3000 I = 3000
G = 2000
X = 2000

M = 1000 T = 4000 DI = Y – T

C = consumption expenditure, DI = disposable income I = autonomous investment
G = government expenditure
X = exports

M = imports
T = tax revenues Y = real GDP

1. What is the value of the government expenditure multiplier in this economy?

a. 0.75
b. 3.0
c. 4.0

d. 5.0
e. none of the above

Answer 1

Simple Government expenditure multilpier (i.e., government expenditure multiplier when except Consumption all other variables are fixed)

Multiplier = 1 / (1 - MPC)

Where MPC is marginal propensity to consume.

Marginal propensity to consume measures the change in consumption due to change in disposable income (DI)

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C = 0.75*DI + 3000

MPC = ΔC / ΔDI

=> MPC = 0.75

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=> Multiplier = 1 / (1 - MPC)

=> Multiplier =1 / (1 - 0.75)

=> Multiplier = 1 / 0.25

=> Multiplier = 4

Thus, the government expenditure multiplier is 4.

Answer: Option (C)

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