If the marginal propensity to consume is 0.75 and transfer payments increase by $30 billion, real GDP will:
A)increase by exactly $30 billion.
B)decrease by exactly $30 billion.
C)increase by more than $120 billion.
D)increase by less than $120 billion.

Question

Quizplus · Accepted Answer

The multiplier effect states that an increase in transfer payments will lead to an increase in real GDP that is greater than the initial increase in transfer payments. The multiplier is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume. In this case, the MPC is 0.75, so the multiplier is 1/(1-0.75) = 4. Therefore, the increase in real GDP will be 4 * $30 billion = $120 billion.

If the Marginal Propensity to Consume Is 0