f the marginal propensity to save is 0.2 and the government decreases its purchases by $20 billion, then real GDP willDecrease by $25 billion.Decrease by $100 billion.Increase by $100 billion.Increase by $25 billion.
Question
f the marginal propensity to save is 0.2 and the government decreases its purchases by 25 billion.Decrease by 100 billion.Increase by $25 billion.
Solution
The answer to this question can be found using the concept of the spending multiplier. The spending multiplier is the reciprocal of the marginal propensity to save (MPS). In this case, the MPS is 0.2, so the spending multiplier is 1/0.2 = 5.
The change in real GDP is equal to the change in government purchases multiplied by the spending multiplier. In this case, the government decreases its purchases by $20 billion, so the change in real GDP is -20 billion * 5 = -100 billion.
Therefore, the real GDP will decrease by $100 billion.
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