Scenario 10.2 A hypothetical open economy has a marginal propensity to import (MPI)equal to 0.2 and a marginal propensity to consume equal to 0.7.Assume that the economy is initially in equilibrium.
Refer to Scenario 10.2.If a tourist visits the country and spends $100 that she brought with her, then what will happen to the equilibrium real GDP?

Question

Quizplus · Accepted Answer

When the tourist spends $100, this increases the economy's expenditure by $100. Given the marginal propensity to consume of 0.7, the total increase in expenditure will be 1/(1-0.7) * $100 = $333.33. Of this additional expenditure, 0.2 (the MPI) will leak out through imports, so the increase in domestic demand will be 0.8 * $333.33 = $266.67. This increase in demand will lead to an increase in real GDP by a multiple of the Keynesian multiplier, which is equal to 1/(1-MPC*MPI) = 1/(1-0.7*0.2) = 1.43. Therefore, the increase in equilibrium real GDP will be $266.67 * 1.43 = $380, or approximately $200 more than the initial increase in expenditure.