Given the MPS = 0.40,with no government and no foreign trade,a $10 billion increase in investment will eventually result in an increase in
A)Consumption by $40 billion.
B)Total spending by $15 billion.
C)Consumption by $15 billion.
D)Total spending by $2.5 billion.

Question

Quizplus · Accepted Answer

The Marginal Propensity to Save (MPS) is 0.40, which means that for every additional dollar earned, 0.40 dollars will be saved and 0.60 dollars will be spent. With no government and no foreign trade, the only source of spending is consumption. Therefore, a $10 billion increase in investment will result in an increase in total spending of $10 billion x 0.60 = $6 billion. Of this $6 billion, $6 billion x 0.60 = $3.6 billion will be spent on consumption. However, this is only the initial impact. The $3.6 billion in additional consumption will lead to a further increase in spending, creating a multiplier effect. Using the formula for the spending multiplier (1/MPS), we can calculate that this initial increase in investment will eventually lead to an increase in consumption of $10 billion x (1/0.40) x 0.60 = $15 billion.