Business, 02.04.2021 04:10 khia22

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 .

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Answer from: breezer20042

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:

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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