Consider two economies, A and B. Economy A has a marginal propensity to consume of 0.9, a net tax rate of 0.3 and a marginal propensity to import of 0.3. Economy B has a marginal propensity to consume of 0.9, a net tax rate of 0.1 and a marginal propensity to import of 0.3. Suppose there is an increase in autonomous investment of $5 billion in each of these economies. Which of the following statements is true?
Group of answer choices
There is a larger decrease in real GDP in Economy A as a result of the change in autonomous investment.
There is a larger increase in real GDP in Economy B as a result of the change in autonomous investment.
There is a larger increase in real GDP in Economy A as a result of the change in autonomous investment.
There is an equal effect on real GDP in Economies A and B as a result of the increase in autonomous investment.
There is a larger decrease in real GDP in Economy B as a result of the change in autonomous investment.
Increase in autonomous investment leads to increase in real GDP.
Economy A
Marginal propensity to consume, MPC = 0.9
MPS = 1 - MPC = 1 - 0.9 = 0.1
Net tax rate, t = 0.3
Marginal propensity to import, MPI = 0.3
Calculate Multiplier -
Multiplier = 1/[MPS + t + MPI]
Multiplier = 1/[0.1 + 0.3 + 0.3] = 1/0.7 = 1.43
The Multiplier in economy A is 1.43
Calculate the increase in real GDP -
Increase in real GDP = Increase in autonomous investment * Multiplier = $5 billion * 1.43 = $7.15 billion
Thus,
The real GDP in economy A will increase by $7.15 billion.
Economy B
Marginal propensity to consume, MPC = 0.9
MPS = 1 - MPC = 1 - 0.9 = 0.1
Net tax rate, t = 0.1
Marginal propensity to import, MPI = 0.3
Calculate Multiplier -
Multiplier = 1/[MPS + t + MPI]
Multiplier = 1/[0.1 + 0.1 + 0.3] = 1/0.5 = 2
The Multiplier in economy B is 2
Calculate the increase in real GDP -
Increase in real GDP = Increase in autonomous investment * Multiplier = $5 billion * 2 = $10 billion
Thus,
The real GDP in economy B will increase by $10 billion.
So,
There is a larger increase in real GDP in Economy B as a result of the change in autonomous investment.
Hence, the correct answer is the option (B).
Consider two economies, A and B. Economy A has a marginal propensity to consume of 0.9,...
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