If the marginal propensity to save (MPS)is 0.5 and net exports falls by $100 million, then
A)real Gross Domestic Product (GDP)will increase by $100 million.
B)real Gross Domestic Product (GDP)will fall by $200 million.
C)real Gross Domestic Product (GDP)will not change.
D)the effect on real Gross Domestic Product (GDP)cannot be determined from the given information.

Question

Quizplus · Accepted Answer

If the marginal propensity to save (MPS) is 0.5, it means that for every additional dollar earned, 50 cents will be saved and 50 cents will be spent. 
If net exports fall by $100 million, it means that there is a decrease in aggregate demand in the economy. This decrease in aggregate demand will lead to a decrease in real GDP. 
The multiplier effect shows that the total impact on GDP will be larger than the initial impact. Given that MPS is 0.5, the spending multiplier will be 2. This means that for every dollar decrease in spending, real GDP will fall by $2. 
Therefore, the initial decrease in net exports of $100 million will result in a decrease in real GDP of $200 million (2*$100 million).

If the Marginal Propensity to Save (MPS)is 0