If the marginal propensity to consume out of disposable income is 0.8, and the government increased spending by $50 million, then national income (GDP) would increase by $________ million.
The national income (GDP) would increase by $250 million. To calculate the increase in national income resulting from an increase in government spending, we can use the multiplier effect, which considers the marginal propensity to consume (MPC). The multiplier is the inverse of the marginal propensity to save (MPS) and is calculated as 1 / MPS. Since the MPC is 0.8, the MPS is 1 - MPC = 1 - 0.8 = 0.2. Therefore, the multiplier is 1 / 0.2 = 5. With the government spending increase of $50 million, the increase in national income would be $250 million.
Understanding the Multiplier Effect
The multiplier effect refers to the impact of an initial change in spending on a country's national income. It measures how much one unit of increase in spending will result in an overall increase in national income. The multiplier effect is important in economic policy-making, especially when analyzing the effects of government spending on the economy.
Calculating the Multiplier
To calculate the multiplier, we need to determine the marginal propensity to consume (MPC). The MPC is the proportion of an increase in disposable income that individuals choose to spend on consumption. In this case, the MPC is given as 0.8, which means that for every additional dollar earned, individuals will spend 80 cents.
To find the multiplier, we first calculate the marginal propensity to save (MPS), which is equal to 1 - MPC. With an MPC of 0.8, the MPS is 1 - 0.8 = 0.2. The multiplier is then calculated as 1 / 0.2 = 5.
Application to Government Spending Increase
When the government increases its spending by $50 million, this injection of funds into the economy will lead to a multiplied effect on national income. By using the multiplier of 5, we can determine that the increase in national income will be 5 times the increase in government spending. Therefore, with a $50 million increase in government spending, the national income would increase by $250 million.
In conclusion, understanding the multiplier effect and the marginal propensity to consume is essential in analyzing the impact of government spending on national income. By applying these concepts, we can predict how changes in government spending will influence overall economic growth.