Let C = 300 + 0.75y and I = 200. Assume no government or foreign sectors. Investment needs to decrease by ________ to decrease equilibrium output by a total of $750.

Question

Quizplus · Accepted Answer

To decrease equilibrium output by $750, we use the multiplier effect. The multiplier is 1/(1-MPC) where MPC is the marginal propensity to consume. Here, MPC = 0.75, so the multiplier = 1/(1-0.75) = 4. A decrease in output of $750 requires a decrease in investment of $750/4 = $187.50.