In the simple Keynesian model with no government or foreign sectors, suppose that the economy is in equilibrium at an output level of $10 trillion with a marginal propensity to consume of 0.8. If investment spending increases by $0.5 trillion, what is the new equilibrium output level?
A) $10.5 trillion
B) $10.8 trillion
C) $12 trillion
D) $12.5 trillion

Question

Quizplus · Accepted Answer

The multiplier in the Keynesian model is 1/(1-MPC), which is 1/(1-0.8) = 5. An increase in investment of $0.5 trillion leads to an increase in output of 5 * $0.5 trillion = $2.5 trillion. Therefore, the new equilibrium output level is $10 trillion + $2.5 trillion = $12.5 trillion.

In the Simple Keynesian Model with No Government or Foreign