If 20 percent of additional income is not spent and business investment spending decreases by $10 billion at the same time that government purchases increase by $20 billion, total output and income will:
A) increase by $50 billion.
B) decrease by $50 billion.
C) increase by $150 billion.
D) decrease by $150 billion.

Question

Quizplus · Accepted Answer

The increase in total output and income can be calculated using the multiplier effect. The marginal propensity to consume (MPC) is 0.8 (since 20% is not spent, 100% - 20% = 80% is spent). The multiplier is 1/(1-MPC) = 1/(1-0.8) = 5. The net increase in spending is the $20 billion increase in government purchases minus the $10 billion decrease in business investment, which equals $10 billion. Applying the multiplier, the total increase in output and income is $10 billion * 5 = $50 billion.

If 20 Percent of Additional Income Is Not Spent and Business