Suppose investment increases by $200 and that the equilibrium level of output rises by $400. Given this information, we know that:

Question

Quizplus · Accepted Answer

The marginal propensity to save (MPS) is the fraction of each additional dollar of income that is saved rather than spent. Since equilibrium output has increased by $400 with a $200 increase in investment, we know that the multiplier is 2 (i.e. ΔY/ΔI = 2). Therefore, the total increase in spending is $400 (i.e. $200 x 2). If we assume that spending is split between consumption and saving, we can use the equation ΔY = ΔC + ΔS, where ΔC is the change in consumption and ΔS is the change in saving. Since we know that ΔY = $400, we can solve for ΔS: ΔS = ΔY - ΔC = $400 - ΔC. If we assume that the MPC + MPS = 1 (i.e. total additional income is either spent or saved), then we can say that ΔC = MPC x ΔY and ΔS = MPS x ΔY. Plugging these in, we get: ΔS = MPS x ΔY = MPS x $400 = $400 - MPC x $400. Solving for MPS, we get: MPS = ($400 - MPC x $400) / $400. Since we know that ΔY/ΔI = 2, we can also say that MPC = ΔC/ΔY = 1 - MPS. Plugging this in, we get: MPS = ($400 - (1 - MPS) x $400) / $400, which simplifies to MPS = 0.5. Therefore, the answer is D.

Suppose Investment Increases by $200 and That the Equilibrium Level