Calculate the values for each of the questions below. Assume that in each countr

Question

Calculate the values for each of the questions below. Assume that in each country there are no taxes, international trade or inflation, and that interest rates are fixed. The Italian government decides to stimulate the economy by sending checks worth $70 billion to Italian consumers. If the (government spending) multiplier is 1.5, calculate the MPC to determine the final change in Italy's real GDP due to the transfer? Please give your answer as a whole number in billions of dollars. The Greek government decides to introduce new austerity measures, which reduce government direct spending by $16 billion. Greece has a marginal propensity to consume of 0.6. What will be the final change in real GDP be as a result of this decreased spending? Please give your answer as a whole number in billions of dollars. The Japanese government decides to stimulate the economy by increasing direct spending by $70 billion. If the final change in real GDP is $280 billion, what is Japanese consumers' marginal propensity to consume (MPC)? Please round your answer to two decimal places.

Explanation / Answer

Spending multiplier = 1 / (1 - MPC)

(1) Multiplier = 1.5

(a) 1 / (1 - MPC) = 1.5

1.5 - 1.5 x MPC = 1

1.5 x MPC = 1.5 - 1 = 0.5

MPC = 0.5 / 1.5 = 1 / 3 = 0.33

(b) A multiplier of 1.5 means that if government spending increases by $1, real GDP increases by $1.5.

So, when spending increases by $70 billion, real GDP increases by $70 billion x 1.5 = $105 billion

NOTE: MPC is a pure number, but increase in real GDP is in terms of billions of dollars. Your question asks to compute MPC, but requires to input a number in terms of $billion. The question is incorrectly worded.

(2) Multiplier = 1 / (1 - 0.6) = 1 / 0.4 = 2.5

As government spending decreases by $1, real GDP decreases by $2.5.

As spending falls by $16 billion, real GDP falls by $16 billion x 2.5 = $40 billion

(3) Multiplier = Final change in real GDP / Change in government spending

= $280 billion / $70 billion

= 4

So,

1 / (1 - MPC) = 4

4 - 4 x MPC = 1

4 x MPC = 3

MPC = 3 / 4 = 0.75

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