Suppose that investment demand increases by $200 billion in a closed and private

Question

Suppose that investment demand increases by $200 billion in a closed and private economy (no government or foreign trade). Assume further that households have a marginl propensity to consume of 80 percent. (a) Compute four rounds of multiplier effects nstructions: Enter your responses rounded to the nearest one decimal place. Changes in This Cumulative Change Cycle's Spending (in billions) 200.0 in Spending (in billions) 200.0 - First cycle cond cycle ird cycle Fourth cycle (b) What will be the final cumulative impact on spending? Instructions: Enter your response rounded to the nearest whole number. billion

Explanation / Answer

In ac closed economy with no government,

Y=C+I

C=0.8Y

dY=0.8dY+dI

0.2dY=dI

dY=dI/0.2

here dI=200

so dY=200/0.2=1000

In the first round thre will be increase in only 200 in Y that increases from investment. In the second round additional increase in Y is 1000 as calculated above. In the third and fourth round there is no increase in Y until there is any further increase in investment. Thus cumulative change in spending is 1000+200=1200

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