If the MPC is 0.5, and the government cuts spending by $400b, the overall effect on GDP will be:
A) a decrease of $400b.
B) an increase of $400b.
C) a decrease of $800b.
D) an increase of $800b.

Question

Quizplus · Accepted Answer

The MPC (Marginal Propensity to Consume) is 0.5, meaning that for every dollar decrease in disposable income, consumer spending will decrease by 50 cents.

If the government cuts spending by $400b, this means that there will be a decrease in the amount of money flowing into the economy.

Given the MPC, this decrease in government spending will result in a decrease in consumer spending by $200b (0.5 x $400b).

Therefore, the overall effect on GDP will be:

Decrease in government spending: -$400b
Decrease in consumer spending: -$200b

Total overall effect on GDP: -$400b - $200b = -$600b

However, the question asks for the effect on GDP, not the change in spending. Therefore, we need to add the change in spending to the initial decrease in government spending to get the final effect on GDP:

Decrease in government spending: -$400b
Increase in savings (opposite of consumer spending decrease): +$200b

Total effect on GDP: -$400b + $200b = -$200b

Therefore, the overall effect on GDP will be a decrease of $200b.

If the MPC Is 0