If an economy's marginal propensity to consume is 0.9 and the marginal propensity to import is 0.1, then an increase in government spending of $2,000 will increase income by:

Question

Quizplus · Accepted Answer

The formula to calculate the change in income due to a change in government spending is:
ΔY = (1/(1-MPC-MPM)) x ΔG

where ΔY is the change in income, MPC is the marginal propensity to consume, MPM is the marginal propensity to import, and ΔG is the change in government spending.

Plugging in the values given in the question,
MPC = 0.9
MPM = 0.1
ΔG = $2000

ΔY = (1/(1-0.9-0.1)) x $2000
ΔY = (1/0.0) x $2000
ΔY = undefined

We get an undefined result because the denominator is zero. This happens because the MPC + MPM = 1, meaning that all income is either consumed or imported. In this case, since the MPM is relatively high, the increase in income is mostly used to import goods instead of consumed domestically.

Therefore, the answer is C) $10,000 as it is not possible to calculate the change in income using the given information.

If an Economy's Marginal Propensity to Consume Is 0