Suppose consumer confidence declines and as a result,consumer spending decreases by $4 billion dollars.Other things equal,if households spend $0.75 of each extra dollar of income and save the remaining $0.25,by how much will spending decrease during the second round through the circular flow?

Question

Quizplus · Accepted Answer

If consumer spending decreases by $4 billion, this will result in a decrease in firms' revenue and profits. As a result, firms will have to reduce their production and cut back on their factors of production such as labor, which will lead to a decrease in households' income. If households spend $0.75 of each extra dollar of income and save the remaining $0.25, this means that for every $1 decrease in income, households will cut their spending by $0.75 and save the remaining $0.25. Therefore, during the second round through the circular flow, spending will decrease by $0.75 x $4 billion = $3 billion.

Suppose Consumer Confidence Declines and as a Result,consumer Spending Decreases