The multiplier for the economy in the above diagram:
A)is 3.
B)is 4.
C)is 4.8.
D)is 5.4.

Question

The multiplier for the economy in the above diagram:
A)is 3. 
B)is 4. 
C)is 4.8. 
D)is 5.4.

Quizplus · Accepted Answer

The multiplier can be calculated by the formula 1/(1-MPC) where MPC is the marginal propensity to consume. In this diagram, MPC is 0.6 (since the consumption line intersects the 45-degree line at a slope of 0.6). Therefore, the multiplier is 1/(1-0.6) = 2.5. However, since there is also government spending represented in the diagram, the total multiplier will be higher. The formula for the total multiplier is 1/(1-MPC+MPT+MPI), where MPT is the marginal propensity to tax and MPI is the marginal propensity to import. In this case, MPT and MPI are not given, so we can assume they are both 0 (i.e. no taxes or imports). Therefore, the total multiplier is 1/(1-0.6+0+0) = 2.5/0.4 = 6.25. However, since the government spending is explicitly included in the diagram and is a positive injection into the economy, we need to add 1 to the multiplier. Therefore, the final multiplier for the economy in the diagram is 6.25+1 = 7.25, which is closest to choice C (4.8 is incorrect and 5.4 is too low).

The Multiplier for the Economy in the Above Diagram