Scenario 10.1
Imagine an economy that does not have international trade and is originally in equilibrium. Then the government increases the level of spending by $350 million because it received a gift from abroad. In this economy, only 65 cents of every dollar is spent, and the rest is saved.
-Refer to Scenario 10.1. Calculate the value of the spending multiplier.

Question

Quizplus · Accepted Answer

The spending multiplier formula is: 1/(1-MPC) where MPC is the marginal propensity to consume. Here, MPC is 0.65 (since only 65 cents of every dollar is spent) and the government spending increased by $350 million. So the initial increase in spending will be multiplied by 1/(1-0.65) or 1/0.35, giving a value of 2.86. Therefore, the value of the spending multiplier is 2.86.

Scenario 10.1 Imagine an Economy That Does Not Have International Trade and Trade