Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. Also suppose that GDP and consumption both rise by $6 billion in the second round of the process.

Question

Suppose that an initial $10 billion increase in investment spending expands GDP by $10 billion in the first round of the multiplier process. Also suppose that GDP and consumption both rise by $6 billion in the second round of the process.
Instructions: In parts a and b, round your answers to 1 decimal place. In part c, enter your answer as a whole number.
What is the MPC in this economy?

GPT-4o mini · Answer

To find the marginal propensity to consume (MPC) in this scenario, we can use the information provided about the initial and subsequent changes in GDP and consumption due to the increase in investment spending.

Initial Investment Spending Increase: $I_0 = $10$ billion (this causes the initial increase in GDP)
First Round GDP Increase: $ΔGDP_1 = $10$ billion
Second Round Consumption Increase: $ΔC_2 = $6$ billion (this follows as consumption increases in response to the change in GDP)

In the first round, the entire increase in investment ($10 billion) leads to an increase in GDP of $10 billion. Then, in the second round, GDP increases by $6 billion due to an increase in consumption.

Step 1: Calculate the Increase in GDP from Consumption

The second round of spending indicates that the increase in GDP of $10 billion led to a consumption increase which is connected to the increase in GDP via the MPC.

Step 2: Determine the MPC

The relationship between the increase in consumption and the increase in GDP can be defined as follows:

\[ ΔC = MPC \times ΔGDP \]

In the second round,

\[ 6 = MPC \times 10 \]

We can now solve for the MPC:

\[ MPC = \frac{ΔC}{ΔGDP} = \frac{6}{10} = 0.6 \]

Final Answer

Thus, the marginal propensity to consume (MPC) in this economy is:

\[ \text{MPC} = 0.6 \]