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Suppose the following list of events describes all of the economic activity resulting from an increase in government spending. Suppose that at each step after the initial one, the marginal propensity to consume is 0.75, and there are no taxes.

Step 0. The government spends $5,000 on meat to host a very large dinner for foreign diplomats.

Step A. The butcher takes the income earned by selling the meat, saves some, and spends the rest on a wedding cake for his daughter.

Step B. The baker who produced the wedding cake saves some of her earnings and uses the rest to purchase beautiful candlesticks as gifts for all of her friends.

Step C. The local candlestick maker saves some of his revenue for retirement and spends the rest on building materials to improve his house.

Instructions: Modify the settings in the interactive tool to represent this event. Then click "Spending Rounds" and use the table to answer the following questions. Round answers to the nearest cent, if necessary.

How much does the baker earn for selling the cake? $

How much does the baker spend on candlesticks? $

1 answer

To find out how much the baker earns from selling the wedding cake and how much she spends on candlesticks, we can follow the steps of the economic activity based on the given marginal propensity to consume (MPC) and the initial government spending.

Step 0:

  • Government spending: $5,000

Step A:

  1. Butcher's earnings: The butcher receives the full amount spent by the government, which is $5,000.
  2. MPC: 0.75, which means the butcher will spend 75% of what he earns on the wedding cake.
    • Butcher spends: \( 0.75 \times 5,000 = 3,750 \)

Step B:

  1. Baker's earnings: The baker earns $3,750 from selling the wedding cake.
  2. Baker's spending: She spends 75% of her earnings on candlesticks.
    • Baker spends: \( 0.75 \times 3,750 = 2,812.50 \)

Summary of Values

  1. How much does the baker earn for selling the cake?

    • Answer: $3,750.00

  2. How much does the baker spend on candlesticks?

    • Answer: $2,812.50

Thus, the answers are:

  • Baker's earnings: $3,750.00
  • Baker's spending on candlesticks: $2,812.50