The income expenditure model predicts that if the marginal propensity to consume is 0.75 and the federal government increases spending by $100 billion, real GDP will increase by:
A)$100 billion.
B)$750 billion.
C)$400 billion.
D)$300 billion.

Question

Quizplus · Accepted Answer

The income-expenditure model assumes that an increase in government spending will increase aggregate demand and shift the AD curve to the right. The magnitude of the shift in AD is determined by the multiplier effect, which is equal to 1/(1-MPC), where MPC is the marginal propensity to consume. In this case, the multiplier is 1/(1-0.75) = 4. Therefore, the increase in real GDP will be equal to 4 times the increase in government spending, or $400 billion.

The Income Expenditure Model Predicts That If the Marginal Propensity