Question

1. If in an economy the PMC = 0.75 and it increases in investment spending by companies (autonomous spending) by $ 500 million, what effect on real GDP will that spending have?

2. If in an economy the PMC = 0.50, and the government wants to increase the real GDP by 200 million, determine in what amount the initial autonomous spending must be modified to achieve the objective?

3. If in an economy the PMC = 0.5 and the personal consumption expenditure of families is reduced by $ 300 million, what will be the effect on the income of that economy?

Answer 1

According to the multiplier effect,
Change in real GDP/Change in spending = 1/(1-MPC)

1. Change in real GDP = Change in spending*[1/(1-MPC)] = 500*[1/(1-0.75)] = 500/0.25 = 2,000
So, real GDP will increase by $2,000 million

2. Change in spending = Change in real GDP*(1-MPC) = 200*(1-0.5) = 200*(0.5) = 100
So, autonomous spending must be increased by $100 million.

3. Change in real GDP = Change in spending*[1/(1-MPC)] = 300*[1/(1-0.5)] = 300/0.5 = 600
So, income will increase by $600 million.