If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3,an autonomous decrease in investment spending of $1 million leads to a $2 million decrease in domestic income and a $600,000 decrease in imports.

Question

Quizplus · Accepted Answer

Using the formula for calculating the multiplier effect of changes in autonomous spending:

Multiplier = 1/(1-MPC)

where MPC is the marginal propensity to consume (MPC = 1 - MPS, where MPS is the marginal propensity to save).

Given MPS = 0.2, MPC = 1-0.2 = 0.8, and MPI = 0.3, we can calculate the multiplier as follows:

Multiplier = 1/(1-0.8-0.3) = 1/(-0.1) = -10

This means that an autonomous decrease in investment spending of $1 million leads to a $10 million decrease in domestic income.

To find the decrease in imports, we use the MPI:

Decrease in imports = MPI x Decrease in income

Decrease in imports = 0.3 x (-$10 million) = -$3 million

Therefore, the statement is false. The decrease in imports would be $3 million, not $600,000.

If the Marginal Propensity to Save Equals 0