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.
-What is the marginal propensity to consume for the economy described in Scenario 10.1?

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is the proportion of an additional dollar of disposable income that is spent. In this scenario, the government has increased spending by $350 million, which is an injection into the economy. The spending multiplier would be 1/ (1-MPC) = 1/ (1-0.65) = 2.86. Therefore, the initial injection of $350 million will generate an additional $1 billion ($350 million x 2.86) in total spending in the economy. Based on this, we can calculate the MPC as follows:

MPC = change in consumption/change in disposable income

Since we know that only 65% (or 0.65) of each additional dollar is spent (the rest is saved), the MPC is 0.65.

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