If the marginal propensity to save (MPS) is 0.5 and net exports falls by $10 million, then
A) real Gross Domestic Product (GDP) will increase by $5 million.
B) real Gross Domestic Product (GDP) will fall by $20 million.
C) real Gross Domestic Product (GDP) will not change.
D) the effect on real Gross Domestic Product (GDP) cannot be determined from the given information.

Question

Quizplus · Accepted Answer

The formula for calculating the change in real GDP due to a change in net exports is:

Change in real GDP = Change in net exports x (1/(1-MPC))

MPC stands for marginal propensity to consume, which is the complement of MPS. MPC + MPS = 1.

In this case, we are given MPS = 0.5. So MPC = 1 - MPS = 0.5.

The change in net exports is given as -$10 million.

Plugging in the values, we get:

Change in real GDP = -$10 million x (1/(1-0.5)) = -$10 million x 2 = -$20 million

Therefore, real GDP will fall by $20 million.

If the Marginal Propensity to Save (MPS) Is 0