Question

3.2If a R200 billion increases in investment spending creates R200 billion of new income in the first round of the multiplier process and R160 billion in the second round. Calculate:
a. the marginal propensity to consume (MPC).
b. the value of the expenditure multiplier in this closed economy.
3.3 Assuming a private closed economy whereby the marginal propensity to consume is 0.9 and investment spending decreases by R1000 billion. What will be the change on equilibrium GDP?

Answer 1

a. The marginal propensity to consume (MPC).

The MPC will be computed as using the following formula:

$\dfrac{\Delta Y}{\Delta I}=\dfrac{360}{200}=\dfrac{1}{1-MPC}$

Therefore,

$\dfrac{1}{MPS}=1.8$

$MPS=0.56$

Therefore, the MPC will be:

$MPC+MPS=1$

$MPC=1-0.56$

$MPC=0.46$

b. the value of the expenditure multiplier in this closed economy. 

The expenditure multiplier is estimated as follows:

$\text{Expenditure multiplier}=\dfrac{1}{MPC}$

$\text{ Thus Expenditure multiplier}=\dfrac{1}{0.46}=2.17$

Assuming a private closed economy whereby the marginal propensity to consume is 0.9 and investment spending decreases by R1000 billion. What will be the change on equilibrium GDP?

$\dfrac{\Delta Y}{\Delta I}=\dfrac{1}{1-MPC}$

$\dfrac{\Delta Y}{-1000}=\dfrac{1}{1-0.9}$

$\dfrac{\Delta Y}{-1000}=10$

$\Delta Y=10*-1000=-10000$

The equilibrium GDP will decrease with 10,000 billion as a result of 1000billion decrease in national investment spending.