Suppose that consumers become more pessimistic about the future and, as a result, reduce their consumption by $10 billion. If the marginal propensity to consume is 0.80, how will this $10 billion reduction in consumption affect the equilibrium level of real GDP?
A) Real GDP will decrease by $8 billion.
B) Real GDP will decrease by $10 billion.
C) Real GDP will decrease by $40 billion.
D) Real GDP will decrease by $50 billion.

Question

Quizplus · Accepted Answer

The multiplier effect is calculated as 1/(1-MPC). With an MPC of 0.80, the multiplier is 5. Therefore, a $10 billion reduction in consumption will decrease real GDP by $10 billion * 5 = $50 billion.

Suppose That Consumers Become More Pessimistic About the Future And