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Answer:
Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) is 0.80 , and the multiplier for this economy is 5 .
Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to –$240 billion . This decreases income yet again, causing a second change in consumption equal to –$192 billion . The total change in demand resulting from the initial change in government spending is –$1.5 trillion .
Explanation:
Note: This question is not complete. The complete question is therefore provided before answering the question as follows:
Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) is , and the multiplier for this economy is .
Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to . This decreases income yet again, causing a second change in consumption equal to . The total change in demand resulting from the initial change in government spending is .
The explanation of the answer is given as follows:
MPC = The portion of the amount households spend of each additional dollar they earn = 0.80
MPS = Marginal propensity to save = 1 - 0.80 = 0.20
Multiplier for this economy = 1 / 0.20 = 5
Change in government purchase = –$300 billion
Initial change in consumption = Change in government purchase * MPC = -$300 * 0.80 = –$240 billion
Second change in consumption = Initial change in consumption * MPC = –$240 billion * 0.80 = –$192 billion
Total change in demand = Change in government purchase * Multiplier for this economy = –$300 billion * 5 = –$1,500 billion, or –$1.5 trillion
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