Question

Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30.

The marginal propensity to consume (MPC) for this economy is (.3/ .7/ 1/ 1.43/ 3.333) , and the simple spending multiplier for this economy is (.3/ .7/ 1/ 1.43/ 3.333).

Suppose the government in this economy decides to decrease government purchases by $300 billion, causing aggregate expenditures initially to fall by $300 billion.

The decrease in government purchases will lead to a decrease in income, generating another change in spending equal to (-90 billion/ -1000 billion/ -500 billion/ -210 billion/ -105 billion). This decreases income yet again, causing a subsequent change in spending equal to (-500 billion/ -147 billion/ -90 billion/ -1000 billion/ -105 billion). The total change in aggregate expenditures resulting from the initial change in government spending is (-2.1 trillion/ -.6 trillion/ -1 trillion/ -.7 trillion).

Answer 1

The marginal propensity to consume (MPC) for this economy is ( 0.70), and the simple spending multiplier for this economy is ( 3.333).
**The proportion of income spent on each additional dollar of income is MPC**
Multiplier=1/(1-MPC)=1/(1-0.7)=3.33

The decrease in government purchases will lead to a decrease in income, generating another change in spending equal to ( -210 billion). This decreases income yet again, causing a subsequent change in spending equal to ( -147 billion). The total change in aggregate expenditures resulting from the initial change in government spending is (-1 trillion).
*********Change in spending=300*0.7=210 billion ****************************
Change in spending in second cycle=210*0.7=147 billion
Total change in spending=300*3.33=1000 billion