In the aggregate expenditure model for a closed economy, assuming investment, government spending and taxes are exogenous, if the marginal propensity to consume is 0.8, a simultaneous 50 unit increase in government spending and a 20 unit decrease in investment will change equilibrium income by:
350 units.
87.5 units.
150 units.
500 units.
Solution:
The correct answer is 150 units.
Equilibrium income will change by 150 units.
Given MPC of 0.8, derive the spending multiplier:
Multiplier =
Multiplier = 5
ΔY = (-20 x 5) + (50 x 5) = -100 + 250 = 150 units
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