An increase in the sensitivity of private spending (consumption,investment,and net exports)to changes in the interest rate ________ the government purchases multiplier.
A)will decrease
B)will increase
C)will not change
D)may increase or may decrease

Question

Quizplus · Accepted Answer

The government purchases multiplier is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume. As the sensitivity of private spending to interest rate changes increases, the MPC will decrease since households and firms will save more in response to higher interest rates. This means that the denominator in the multiplier formula will get smaller, making the multiplier larger. Therefore, if the sensitivity of private spending to interest rate changes increases, the government purchases multiplier will decrease.

An Increase in the Sensitivity of Private Spending (Consumption,investment,and Net