If the marginal propensity to save is 0.25, investment spending is $700 million, and the government increases its purchases of goods and services by $100 million, then real GDP increases by:
A)$25 million.
B)$175 million.
C)$400 million.
D)$2,800 million.

Question

Quizplus · Accepted Answer

The formula to calculate the change in real GDP due to government spending is:

∆Y = (1 / (1 - MPC)) x ∆G

Where MPC is the marginal propensity to consume (MPC + MPS = 1), which in this case is assumed to be 0.75 (1 - 0.25).

∆G = $100 million (given)

∆Y = (1 / 0.75) x $100 million = $133.33 million (rounded to the nearest million)

However, the question asks for the change in real GDP due to both government spending and investment spending. Therefore, we need to add the initial investment spending of $700 million to the change in real GDP due to government spending:

Total change in real GDP = $700 million + $133.33 million = $833.33 million = $833 million (rounded to the nearest million)

Therefore, the answer is C.

If the Marginal Propensity to Save Is 0