In 1978 , Government increased its investment spending by \$ 5 billion. Given that the MPC (Marginal Propensity to Consume) is \(0.75\), and assuming further that the economy is initially in equilibrium at \(\$ 470\) billion, a) Determine its effect on equilibrium NNP; b) Assuming that instead of an increase by \(\$ 5\) billion, there was a drop in investment by \(\$ 5\) billion, what will happen to equilibrium NNP? c) Give the significance of your results.

Marginal Propensity to Consume, simply put, is the portion of extra income that a household is likely to spend rather than save. Think of it as if for every dollar you receive, how many cents would you spend? In our scenario, with an MPC of 0.75, 75 cents out of each additional dollar are spent. This is a crucial number because it affects how spending ripples through the economy.

Knowing the MPC helps us predict changes in consumer spending as a result of changes in income. If a government policy, for example, increases a household's disposable income, MPC can estimate the increase in consumption that will follow. This becomes vital when evaluating policy impacts on economic activity, like our textbook problem where a change in government investment spending occurs.

Government investment spending is a powerful economic tool that directly influences the level of aggregate demand. It’s a bit like adding fuel to the economy's engine. When the government spends more on infrastructure, research, or education, it injects additional funds into the economic system, which can potentially lead to increased production and employment.

Higher investment spending by the government can translate to more jobs, which means more income for households. Those households will then spend a percentage of this income, determined by the MPC, on goods and services. This chain of events can increase overall economic output, and in our original exercise, contributes to a higher equilibrium National Net Product (NNP). Conversely, when government investment spending decreases, it can have a contracting effect on the economy.

The multiplier effect is the economic magic that boosts the impact of government investment spending. In essence, it describes how an initial injection of spending leads to a greater than proportionate change in the overall economic activity. It's like a snowball rolling down a hill—it starts small but grows in size as it picks up more snow.

The size of the multiplier depends on the MPC and is calculated using the formula \( Multiplier = \frac{1}{(1-MPC)} \). The higher the MPC, the larger the multiplier effect. In our exercise, with an MPC of 0.75, the multiplier is 4. This implies that for every dollar the government spends, the NNP increases by four dollars. That's significant! It demonstrates why the MPC and the multiplier effect are so crucial when the government is considering how to intervene in the economy to encourage growth.