1. A small country with a marginal propensity to save of 0.30 and a marginal pro

Question

1. A small country with a marginal propensity to save of 0.30 and a marginal propensity to import of 0.20 experiences an increase in exogenous spending of $3 million.

a. According to the spending multiplier, by how much will domestic product and income change?

b. What is the change in the country's imports?

c. If this country is large (rather than small), what effect will this have on foreign product and income? Explain.

d. Will the change in foreign product and income tend to counteract or reinforce the change in the first country's domestic product and income? Explain.

Explanation / Answer

a) spending multiplier= 1/(1-c+m)

1-c= 0.30 and m= 0.20

Multiplier= 1/(0.3+0.2) = 2

Change in domestic product and income= 2*3= 6million.

b. Change in country's imports = 0.2*6= 1.2million.

c. If this country is large increase in domestic product of the home country will lead to increase in demand for imports which will increase the income of foreign country in the world market.

d. The change in foreign product and income tends to reinforce income of the first country. This is so becuase their higher will demand more goods from first country. This leads to increases in exports of the first country and thus raises it's income.

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