If equilibrium real GDP demanded rises from $4 trillion to $6 trillion when government purchases increase by $1 trillion,how large is the marginal propensity to consume?
A)0.8
B)0.4
C)0.5
D)0.2
E)2

Question

Quizplus · Accepted Answer

The formula for the spending multiplier is:
Spending Multiplier = 1 / (1 - MPC)
where MPC is the marginal propensity to consume.

We know that equilibrium real GDP demanded has increased by $2 trillion ($6 trillion - $4 trillion) when government purchases increase by $1 trillion. This implies a spending multiplier of:
Spending Multiplier = ΔY / ΔG = $2 trillion / $1 trillion = 2

Substituting into the formula for the spending multiplier:
2 = 1 / (1 - MPC)
1 - MPC = 1/2
MPC = 1 - 1/2 = 1/2

Therefore, the marginal propensity to consume is 0.5 or 50%. The correct answer is C).

If Equilibrium Real GDP Demanded Rises from $4 Trillion to $6