Assume that the economy is at equilibrium at $10 trillion, with a marginal propensity to consume of 0.75. If exports rise by $0.5 trillion and imports increase by $0.7 trillion, equilibrium income will

Question

Quizplus · Accepted Answer

The initial equilibrium level of GDP is $10 trillion, and the marginal propensity to consume (MPC) is 0.75. This means that for every additional $1 of income, consumption will increase by $0.75, while the remaining $0.25 goes to savings or taxes.
If exports increase by $0.5 trillion, this will directly increase GDP by the same amount. However, if imports also increase by $0.7 trillion, this will reduce GDP by $0.7 trillion since imports are a leakage from the circular flow of income (i.e. money spent on imports is not spent on the domestic economy). 
The net effect on GDP is therefore a decrease of $0.2 trillion, calculated as follows:
Net exports = exports - imports = $0.5 trillion - $0.7 trillion = -$0.2 trillion
Change in Real GDP = Change in Aggregate Expenditure = MPC × Change in Disposable Income
Change in Disposable Income = Net exports = -$0.2 trillion
Change in Real GDP = 0.75 × (-$0.2 trillion) = -$0.15 trillion
Equilibrium income will fall by $0.15 trillion, which is equal to $0.15 trillion = $0.15 × 1000 billion = $150 billion or $0.15 × 1000000 million = $150 million. This is equivalent to $150 per year for every million people in the economy. 
Therefore, the best answer is B, fall by $0.8 trillion.

Assume That the Economy Is at Equilibrium at $10 Trillion