If government increases its purchases by $20 billion and the MPC is 0.9,what will the resulting increase in the consumption component of AD be?
A)$2 billion
B)$18 billion
C)$180 billion
D)$200 billion

Question

Quizplus · Accepted Answer

The increase in consumption is calculated using the spending multiplier, which is 1/(1-MPC). Here, MPC is 0.9, so the multiplier is 10. The increase in government purchases is $20 billion, so the increase in AD is 10 * $20 billion = $200 billion. However, the increase in consumption alone is 0.9 * $200 billion = $180 billion.

If Government Increases Its Purchases by $20 Billion and the MPC