Consumption Quiz

Question 1

If policies were put in place to increase investment spending by $50 billion, what would be the potential effect on RGDP if mpc = .8? Explain? 

Spending multiplier

M = 1/(1-mpc) OR 1/MPS

The GDP Increases by the spending multiplier multiplied by the original amount, and is determined by the MPC

So, the real GDP would increase by the spending multiplier, which in this case is 5, times the original amount. Therefore, the increase in investment spending, which divided by the change in income equals the 

MPC, would have an equation of MPC = .8 = 50,000 / .8 ... , the change in income is 50 billion / .8 

the real GDP is 5 times its original amount. ((1/.2) = 5)

Question 2

If disposable income remains stable, how can consumption change?

Consumer Spending

MPC = change in consumer spending / change in disposable income

Consumer spending is not reliant on disposable income, in fact, consumer spending can change (causing the MPC to change) without disposable income being changed. Since consumer spending is the numerator, as it increases and disposable income remains constant, the MPC will increase. On the other hand if consumer spending decreases the MPC will decrease, if disposable income remains constant.