If a $100 billion decrease in investment spending causes income to decline by $100 billion in the first round of the multiplier process and by $75 billion in the second round, income will eventually decline by:
A)$400 billion.
B)$300 billion.
C)$200 billion.
D)$500 billion.

Question

Quizplus · Accepted Answer

The multiplier effect shows that the total change in income is greater than the initial change in spending. Here, the multiplier is 1/(1-MPC), where MPC is the marginal propensity to consume. Given the decline of $100 billion in the first round and $75 billion in the second, the MPC is 0.75. The multiplier is 4, so the total decline in income is $100 billion * 4 = $400 billion.

If a $100 Billion Decrease in Investment Spending Causes Income