The income-expenditure model predicts that if the marginal propensity to consume is 0.8 and the federal government decreases spending by $200 billion, real GDP will fall by:
A)$160 billion.
B)$200 billion.
C)$800 billion.
D)$1,000 billion.

Question

Quizplus · Accepted Answer

The spending multiplier is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume. Here, MPC = 0.8, so the multiplier is 1/(1-0.8) = 5. A $200 billion decrease in spending will lead to a decrease in GDP of 5 * $200 billion = $1,000 billion.

The Income-Expenditure Model Predicts That If the Marginal Propensity to Consume