Imagine an isolated economy made up of individuals who are both consumers and se
ID: 1221782 • Letter: I
Question
Imagine an isolated economy made up of individuals who are both consumers and sellers. The table below tracks the income and spending of a small part of this economy: 8 individuals called A through H. Naturally, the whole economy includes additional people. Assume that individual A has just decided to spend $10,000 in a store owned by individual B and that individual B, along with everyone else in this economy, has a marginal propensity to consume (MPC) of 0.75.
a. Assume that every individual that receives additional income will spend an additional amount according to his or her MPC. Use this information to complete the table below.
Instructions: Round your answers to 2 decimal places. (USING THE DATA ON TABLE)
b. What is the cumulative expenditure for individuals A through H? _____$
c. Using the MPC value for this economy, what is the expenditures multiplier? ______$
d. Using the expenditures multiplier computed above, what is the total increase in real GDP from the additional $10,000 worth of expenditure? _____$
Explanation / Answer
MPC = 0.75
So, out of every $1 increase in income, $0.75 will be spent.
(a)
(b) Expenditure multiplier = 1 / (1 - MPC) = 1 / (1 - 0.75) = 1 / 0.25 = 4
So, for every $1 increase in income, total increase in real GDP is $4.
(c) Total increase in real GDP = $10,000 x 4 = $40,000
Individual Extra income ($) Extra expenditure ($) A - 10,000.00 B 10,000.00 7,500.00 C 7,500.00 5,625.00 D 5,625.00 4,218.75 E 4,218.75 3,164.06 F 3,164.06 2,373.05 G 2,373.05 1,779.79 H 1,779.79 1,334.84 TOTAL 34,660.64 35,995.48