If the marginal propensity to consume is 0.8, a $200 billion increase in government purchases, other things constant, would:
A)increase consumption in the first round by $80 billion and overall aggregate demand by $400 billion.
B)increase consumption in the first round by $160 billion and overall aggregate demand by $1 trillion.
C)increase consumption in the first round by $200 billion and overall aggregate demand by $1 trillion.
D)increase consumption in the first round by $800 billion and overall aggregate demand by $4 trillion
E)increase consumption in the first round by $400 billion and overall aggregate demand by $4 trillion.

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) of 0.8 means that 80% of any additional income will be spent. In the first round, consumption increases by 0.8 * $200 billion = $160 billion. The overall increase in aggregate demand is calculated using the spending multiplier, which is 1/(1-MPC) = 1/0.2 = 5. Therefore, the total increase in aggregate demand is 5 * $200 billion = $1 trillion.

If the Marginal Propensity to Consume Is 0