Consider the simplest macro model with demand-determined output.Suppose an increase in business confidence leads firms to increase investment in new equipment by $100 million.The marginal propensity to spend in this economy is 0.75.What is the increase in expenditure in this economy during the initial first round of spending?
A)$75 million
B)$25 million
C)$100 million
D)$400 million
E)$500 million

Question

Quizplus · Accepted Answer

In a demand-determined output model, an increase in investment spending by firms will lead to an increase in aggregate demand by the same amount (assuming no crowding out effects). The initial first round of spending will therefore be equal to the increase in investment spending, which is $100 million. The marginal propensity to spend tells us how much of this initial increase in expenditure will be spent again by households and firms in subsequent rounds of spending. However, for the initial first round of spending, the increase in expenditure is simply equal to the increase in investment spending. Therefore, the correct answer is C) $100 million.

Consider the Simplest Macro Model with Demand-Determined Output