Consider two closed economies that are identical except for their marginal prope
ID: 1165979 • Letter: C
Question
Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real income and planned expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph.
The first economy's MPC is 0.5. Therefore, its initial planned expenditure line has a slope of 0.5 and passes through the point (100, 100).
The second economy's MPC is 0.75. Therefore, its initial planned expenditure line has a slope of 0.75 and passes through the point (100, 100).
Now, suppose there is an increase of $20 billion in planned investment in each economy.
Explanation / Answer
multiplier for the first economy = 1/1-MPC = 1/(1-0.5) = 2
The change in equilibrium real income = $20 * 2 = $40
multiplier for the second economy = 1/(1-0.75) = 4
the change in equilibrium real income for second economy = $20 * 4 = $80.