Given the MPS = 0.40,with no government and no foreign trade,a $10 billion increase in investment will eventually result in an increase in
A)Consumption by $40 billion.
B)Total spending by $15 billion.
C)Total spending by $25 billion.
D)Total spending by $2.5 billion.

Question

Quizplus · Accepted Answer

The MPS (marginal propensity to save) is 0.40, which means that for every extra dollar of income, households will save 40 cents and spend 60 cents. Therefore, with no government and no foreign trade, the initial increase in investment of $10 billion will result in a 0.60 x $10 billion = $6 billion increase in consumption spending (since the rest, $4 billion will be saved).

However, this $6 billion increase in consumption spending will generate additional rounds of spending as the recipients of this income also spend part of it. The total increase in spending will be determined by the multiplier effect which is equal to 1/MPS, or 1/0.40 = 2.5.

Therefore, the total increase in spending will be $6 billion x 2.5 = $15 billion. This is the increase in total spending, including both consumption and investment spending.