Question

If there a $2billion increase in government spending, other things being equal, what would be the resulting change in aggregate demand, and how much of the change would a change in consumption, if the MPC were the following: 1/3? 1/2? 2/3? 3/4? 4/5?

Answer 1

Answer.) Governemnt expenditure multiplier is given by = [ 1/(1-MPC)] , note that there is a $2 billion increase in government spending.

1.) if MPC = 1/3

Multiplier = [1/(1-1/3)] = 1.5

thus resulting change in aggregate demand = (1.5)( $2 billion ) = $3 billion

2.) if MPC = 1/2

Multiplier = [1/(1-1/2)] = 2

thus resulting change in aggregate demand = (2)( $2 billion ) = $4 billion

3.) if MPC = 2/3

Multiplier = [1/(1-2/3)] = 3

thus resulting change in aggregate demand = (3)( $2 billion ) = $6 billion

4.) if MPC = 3/4

Multiplier = [1/(1-3/4)] = 4

thus resulting change in aggregate demand = (4)( $2 billion ) = $8 billion

5.) if MPC = 4/5

Multiplier = [1/(1-4/5)] = 5

thus resulting change in aggregate demand = (5)( $2 billion ) = $10 billion