Question

Timmy has recently won the jackpot. However, he decides to take this $200,000 that he won and invest it into his father's company. The marginal propensity to consume is currently 0.70.

a) what is the spending multiplier?

b) what is the change in equilibrium/aggregate income?

c) what would happen to equilibrium/aggregate income if Timmy decided to consume or spend the $200,000 instead of investing it?

Show all calculations.

Answer 1

A) spending multiplier = (1÷ MPS )

​​​​​​Here MPS = marginal propensity to save.

MPC + MPS =1

​​​​​​MPC = 0.7

Therefore, MPS = 1- 0.7

​​​​ = 0.3

Multiplier= 1÷ 0.3

   = 3.33

​​​​​(B) aggregate income of the economy=

C + G + I + X - M

Here, C is private final consumption expenditure.

G is government expenditure

I denotes the investment or capital formation done by the private sector..

X shows exports of the economy.

M denotes imports.

If if he invests the jackpot money in his father's business, it will increase the investment of the private sector.

And therefore equilibrium income will also increase.

(C)

if he decides to consume or spend two lakh dollars instead of investing it in their own company., It will become the part of 'C ' that is the consumption expenditure. And consumption expenditure of the private-sector increases the equilibrium level of income.