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

Instructions: In parts a and b, round your answers to 1 decimal place. In part c, enter your answer as a whole number.
If, instead, GDP and consumption both rose by $8 billion in the second round, what would have been the size of the multiplier?

Answer 1

To calculate the size of the multiplier, we can use the formula:

\[ \text{Multiplier} = \frac{\text{Change in GDP}}{\text{Initial Change in Spending}} \]

The initial change in investment spending is given as $10 billion.

Part a:

In the first round, GDP increased by $10 billion, so the total change in GDP after the second round must be considered. In this case, we will assume that the second round effects need to be calculated based on the $8 billion increase in GDP that would occur in the second round.

So the total change in GDP after the first and second rounds would be:

\[ \text{Total Change in GDP} = 10 \text{ billion} + 8 \text{ billion} = 18 \text{ billion} \]

Now apply the multiplier formula:

\[ \text{Multiplier} = \frac{18 \text{ billion}}{10 \text{ billion}} = 1.8 \]

Part b:

The size of the multiplier, rounded to one decimal place, is:

\[ \text{Multiplier} = 1.8 \]

Part c:

Next, calculate the size of the multiplier in terms of how many full rounds of additional GDP you get from the initial increase in spending, which is stated here simply as the total change. The total GDP increase is $18 billion from an initial $10 billion investment, which means we can conclude:

\[ \text{Total GDP increase} = 18 \text{ billion} \]

So the size of the multiplier expressed as a whole number (rounded from 1.8):

\[ \text{Multiplier} = 2 \]

Final Answers:

• Part a: 1.8
• Part b: 1.8
• Part c: 2