Let the marginal propensity to consume equal 0.9, the proportional income tax rate equal 0.2, the marginal propensity to import equal 0.12, the sensitivity coefficient of investment and the interest rate equal 0.03, and the exchange rate sensitivity to parity differential equal 0.1. In this case, the simple, pure government spending multiplier must equal
A) 10.
B) 3.8.
C) 2.5.
D) 2.2.
E) none of the above.

Question

Quizplus · Accepted Answer

The simple government spending multiplier is calculated as 1 / (1 - MPC * (1 - tax rate) + MPM), where MPC is the marginal propensity to consume, and MPM is the marginal propensity to import. Substituting the given values: 1 / (1 - 0.9 * (1 - 0.2) + 0.12) = 1 / (1 - 0.72 + 0.12) = 1 / 0.4 = 2.5.

Let the Marginal Propensity to Consume Equal 0