Question

24. If $1,000 of additional spending occurs and the marginal propensity to consume is 0.8, the total effect on the economy is an increase of_ in income or output. A) $800 B) $1,000 C) $5,000 D) $8,000

Answer 1

Answer : 24) The answer is option C.

Multiplier = 1 / (1 - MPC)

MPC = Marginal propensity to consume = 0.8

So,

Multiplier = 1 / (1 - 0.8)

=> Multiplier = 5

Changes in income or output = Multiplier * Changes in spending

=> Changes in income or output = 5 * 1,000

=> Changes in income or output = $5,000

Therefore, here the income or output increases by $5,000 in the economy. So, option C is correct.