Answer:
a. Overall increase in income (Y) for Spendia is $500 million, while overall increase in income (Y) for Savia is $200 million
b. The expenditures multiplier of this third nation is <u>2.50</u> suggesting an MPC of <u>0.6</u>.
Explanation:
a. Considering the multiplier effect, what will be the overall increase in income (Y) for each nation?
<u>For Spendia</u>
MPC = Marginal propensity to consume = 0.8
MPS = Marginal propensity to save = 1 - 0.8 = 0.2
Multiplier = 1 / MPS = 1 / 0.2 = 5
Overall increase in income (Y) for Spendia = Increase in gross investment * Multiplier = $100 million * 5 = $500 million
<u>For Savia</u>
MPC = 0.5
MPS = 1 - 0.5 = 0.5
Multiplier = 1 / MPS = 1 / 0.5 = 2
Overall increase in income (Y) for Savia = Increase in gross investment * Multiplier = $100 million * 2 = $200 million
b. Now assume that a third nation experiences an increase of $250 million in its income and its gross investment (I) increases by the same amount as Spendia and Savia, which is $100 million.
Note that generally in macroeconomics, savings (S) is equal to gross investment (I). Consequently, it is assumed that an increase in gross investment (I) eqauls to an increase in savings (S).
Based on this, we have:
Increase in income (Y) = $250 million
Increase in gross investment (I) = Increase in savings (S) = $100 million
MPS = Increase in savings / Increase in income = $100 / $250 = 0.40
Multiplies = 1 / MPS = 1 / 0.4 = 2.5
MPC = 1 - MPS = 1 - 0.4 = 0.6
Therefore, the expenditures multiplier of this third nation is <u>2.50</u> suggesting an MPC of <u>0.6</u>.
