Exercises: Spending Multipliers

The marginal propensity to consume (MPC) in an economy is 0.8. Compute the marginal propensity to save (MPS) and the simple spending multiplier. Write the formula you use for each.

When a household's disposable income rises by $\$500$ per month, its consumption rises by $\$400$ per month. Compute the household's MPC and MPS.

The spending multiplier in an economy is 4. Autonomous spending increases by $\$50$ billion. Compute the change in real GDP, ignoring price-level effects.

The MPC in an economy is 0.75. (a) Compute the spending multiplier and the tax multiplier. (b) By how much does real GDP change if the government increases spending by $\$40$ billion? (c) By how much does real GDP change if the government cuts taxes by $\$40$ billion? Explain why the answers to (b) and (c) differ.

Business investment in an economy falls by $\$30$ billion because firms are pessimistic about future sales. When disposable income rises by $\$1{,}000$ in this economy, saving rises by $\$200$. Compute the MPS, the MPC, the spending multiplier, and the resulting change in real GDP. Explain in one or two sentences why the final change is larger than the initial $\$30$ billion drop.

The MPC is 0.9. The government raises both its spending and taxes by $\$100$ billion. (a) Compute the change in real GDP caused by the increase in spending alone. (b) Compute the change caused by the increase in taxes alone. (c) Compute the net change, and explain why a balanced-budget change is not neutral.

An economy has real GDP of $\$4{,}800$ billion while full-employment output is $\$5{,}000$ billion. The MPC is 0.8, and you may ignore price-level changes. (a) Compute the size of the output gap. (b) Compute the increase in government spending needed to close the gap. (c) Compute the tax cut needed to close the gap. (d) Explain why the required tax cut is larger than the required spending increase. (e) Explain two reasons why the actual effect of the policy might be smaller than your calculation.

The government spends an extra $\$100$ million on a highway project, and the MPC is 0.6. (a) Compute the additional spending generated in each of the first four rounds, counting the initial $\$100$ million as round 1. (b) Compute the total change in real GDP after all rounds using the multiplier. (c) In the real world, the measured multiplier is often smaller than the simple formula. Explain how taxes and imports act as leakages that reduce it.