Suppose that a hypothetical economy is categorized by the following model: C = 8

Question

Suppose that a hypothetical economy is categorized by the following model:

C = 800 + 0.6DI
I = 500
G = 75
T = 180
X = 25
IM = 15

where C represents consumption, DI represents disposable income, I represents investment, G represents government purchases, T represents net taxes, Y represents real GDP, X represents exports, and IM represents imports.

The oversimplified multiplier formula tells us the change in equilibrium GDP with respect to a one-unit change in any component of spending.

What is the value of the oversimplified multiplier formula in this case?

Explanation / Answer

Here, the MPC = 0.6. We get that from the consumption equation. So, the MPS = 0.4. The fiscal multiplier is 1/MPS. So, the simplified fiscal multiplier is 1/0.4 = 2.5

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