In an economy that has no foreign trade, if real GDP declines by $160 million following a decline in investment spending of $40 million, then the marginal propensity to consume must be equal to _____.

Question

Quizplus · Accepted Answer

The formula for the simple Keynesian model is:

Y = C + I + G

Where Y is real GDP, C is consumption, I is investment, and G is government spending.

If investment spending (I) declines by $40 million, then real GDP (Y) will decline by $160 million.

Using the formula for the simple Keynesian model, we can set up the following equation:

Y = C + I + G 
Y = C + ($40 million) + 0 
Y = C + $40 million

We know that when Y declines by $160 million, I declines by $40 million. Therefore, we can substitute the values in the equation and get:

$160 million = MPC x $40 million

Where MPC is the marginal propensity to consume. Solving for MPC, we get:

MPC = $160 million / $40 million 
MPC = 4

Therefore, the marginal propensity to consume must be equal to 4.

In an Economy That Has No Foreign Trade, If Real