If the marginal propensity to consume is 0.75 and government spending decreases by $2,000 billion,what is the change in GDP?
A) -$2,000 billion
B) -$8,000 billion
C) $2,000 billion
D) $1,500 billion
E) $8,000 billion

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is the fraction of a change in income that is spent. If the MPC is 0.75, then for every $1 decrease in government spending, there will be a decrease in consumption spending of $0.75.

To calculate the change in GDP, we need to use the multiplier effect:

multiplier = 1 / (1 - MPC) = 1 / (1 - 0.75) = 4

This means that a decrease in government spending of $2,000 billion will lead to a total decrease in GDP of:

change in GDP = multiplier * change in government spending 
change in GDP = 4 * (-$2,000 billion) 
change in GDP = -$8,000 billion

Therefore, the best choice is B) -$8,000 billion because it is the result of applying the multiplier to the change in government spending.

If the Marginal Propensity to Consume Is 0