Suppose that a financial crisis decreases investment spending by $100 billion and the marginal propensity to consume is 0.8. Assuming no taxes and no trade, real GDP will _____ by _____.

Question

Quizplus · Accepted Answer

The decrease in real GDP can be calculated using the multiplier effect formula: 1/(1 - MPC) * change in spending. With an MPC of 0.8, the multiplier is 1/(1-0.8) = 5. Therefore, a $100 billion decrease in investment spending leads to a 5 * $100 billion = $500 billion decrease in real GDP.

Suppose That a Financial Crisis Decreases Investment Spending by $100