If a $1,000 increase in income leads to an $800 increase in consumption expenditures,then the marginal propensity to consume is
A)0.2 and the multiplier is 1.25.
B)0.8 and the multiplier is 5.
C)0.2 and the multiplier is 1.25
D)0.8 and the multiplier is 8.

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is the fraction of the additional income that is spent on consumption. In this case, the MPC is:

MPC = change in consumption / change in income
MPC = $800 / $1,000
MPC = 0.8

The multiplier is the ratio of the change in equilibrium output to the initial change in spending. The formula for the multiplier is:

Multiplier = 1 / (1 - MPC)

Substituting MPC = 0.8, we get:

Multiplier = 1 / (1 - 0.8)
Multiplier = 5

Therefore, the correct answer is B, with MPC = 0.8 and the multiplier = 5.

If a $1,000 Increase in Income Leads to an $800