If the marginal propensity to consume is 0.75 and marginal propensity to import is 0.15, then an increase in government spending by 200 will increase GDP by:

Question

Quizplus · Accepted Answer

To calculate the increase in GDP, we use the formula:

ΔY = ΔG + ΔC + ΔI + ΔNX

Where:
ΔY = increase in GDP
ΔG = increase in government spending
ΔC = change in consumption
ΔI = change in investment
ΔNX = change in net exports (exports-imports)

Assuming that there is no change in investment and net exports, we can simplify the formula:

ΔY = ΔG + ΔC

We know that the marginal propensity to consume is 0.75, which means that for every increase in income, consumption will increase by 0.75. Therefore, the change in consumption can be calculated as:

ΔC = MPC x ΔY

ΔC = 0.75 x ΔY

We also know that the marginal propensity to import is 0.15, which means that for every increase in income, imports will increase by 0.15. Therefore, the change in imports can be calculated as:

ΔImports = MPI x ΔY

ΔImports = 0.15 x ΔY

Since we are assuming no change in net exports, we can assume that exports remain constant, which means that:

ΔNX = ΔExports - ΔImports

ΔNX = 0 - 0.15 x ΔY

Putting it all together:

ΔY = ΔG + ΔC + ΔI + ΔNX

ΔY = ΔG + 0.75 x ΔY + 0 + (0 - 0.15 x ΔY)

Simplifying the equation:

ΔY = ΔG + 0.75ΔY - 0.15ΔY

ΔY = ΔG + 0.60ΔY

ΔY - 0.60ΔY = ΔG

0.40ΔY = ΔG

ΔY = ΔG/0.40

ΔY = 200/0.40

ΔY = 500

Therefore, an increase in government spending by 200 will increase GDP by 500.

If the Marginal Propensity to Consume Is 0