If the marginal propensity to consume (MPC) is 0.75 and government purchases increase by $100 billion, then
A) equilibrium real Gross Domestic Product (GDP) will increase by $400 billion.
B) equilibrium real Gross Domestic Product (GDP) will increase by $200 billion.
C) equilibrium real Gross Domestic Product (GDP) will increase by $40 billion.
D) the effect on equilibrium real Gross Domestic Product (GDP) cannot be determined from the given information.

Question

Quizplus · Accepted Answer

The multiplier effect formula is 1/(1-MPC). With an MPC of 0.75, the multiplier is 1/(1-0.75) = 4. Therefore, a $100 billion increase in government purchases would increase equilibrium real GDP by 4 * $100 billion = $400 billion.

If the Marginal Propensity to Consume (MPC) Is 0