18 Consider two nations, Spendia and Savia. The MPC for Spendia is 0.8, and the

Question

18

Consider two nations, Spendia and Savia. The MPC for Spendia is 0.8, and the MPC for Savia is 0.5. Assume that both nations experience an increase in gross investment (I) of $100 million at their existing GDP levels. Considering the multiplier effect, what will be the overall increase in income (Y) for each nation? The increase in income for Spendia is $ million, describing an expenditures multiplier of. The increase in income for Savia is $ million, describing an expenditures multiplier of. b. Now assume that a third nation experiences an increase of $250 million in its income and its gross investment (I) increases by the same amount as Spendia and Savia, which is $100 million. Round your answers to 2 decimal places. The expenditures multiplier of this third nation is, suggesting an MPC of .

Explanation / Answer

a. As we know expenditure multiplier = 1 / (1 - MPC)

With an MPC of 0.80, the simple expenditure multiplier is 1/ (1-0.80) = 5, so the $100 initial increase in investment ultimately increases output by 5 x $100 = $500.

With an MPC of 0.50, the simple expenditure multiplier is 1/ (1-0.50) = 2, so the $100 initial increase in investment ultimately increases income by 2 x $100 = $200.

So the increase in Spenda's income is $500, describing an expenditure multiplier of 5.

And the increase in Savia's income is $200, describing an expenditure multiplier of 2.

b. Expenditure multiplier * Increase in gross investment = Increase in Income

Expenditure Multiplier = $250 / $100 = 2.5

As we know Expenditure multiplier is 1 / (1 - MPC)

1 / (1 - MPC) = 2.5

1 - 2.5 = -2.5 MPC

MPC = 0.6

So the expenditure multiplier of the third country is 2.5 and MPC is 0.6.

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