If 12.5 percent of additional income is not spent on new goods and services, an increase of $50 billion in nonincome-determined spending will cause economic activity to increase by:
A) $12.5 billion.
B) $62.5 billion.
C) $400.0 billion.
D) $625.0 billion.

Question

Quizplus · Accepted Answer

The multiplier effect in economics suggests that an initial increase in spending will lead to a larger increase in economic activity. The multiplier is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume, or the fraction of additional income that is spent. If 12.5% of additional income is not spent, then 87.5% (100% - 12.5%) is spent, making the MPC 0.875. The multiplier is thus 1/(1-0.875) = 8. An initial increase of $50 billion in spending, therefore, results in an increase in economic activity of 50 billion * 8 = $400 billion.

If 125 Percent of Additional Income Is Not Spent on New