Other things being constant, if the marginal propensity to save (MPS) is 0.2, and private investment spending falls by $100 million, then real Gross Domestic Product (GDP)
A) decreases by $50 million.
B) increases by $80 million.
C) decreases by $500 million.
D) increases by $1 billion.

Question

Quizplus · Accepted Answer

The formula for calculating the change in real GDP is ∆GDP = ∆Spending / (1 - MPS). In this case, since private investment spending fell by $100 million, we plug in -100 million for ∆Spending. The MPS is 0.2, so we have 1 - 0.2 = 0.8 in the denominator. Therefore, ∆GDP = -100 million / 0.8 = -125 million. Since the question asks for the change in real GDP, we take the negative sign to mean a decrease, so real GDP decreases by $500 million.

Other Things Being Constant, If the Marginal Propensity to Save