Given the following information, what is the spending multiplier in each case? a. MPC ¼ .90, MPI ¼ .10 b. MPC ¼ .90, MPI ¼ .20 c. MPC ¼ .80, MPI ¼ .30 d. MPC ¼ .90, MPI ¼ 0

Marginal Propensity to Consume (MPC) is one of the fundamental concepts in economics, particularly in the Keynesian model. It refers to the portion of additional income that a household is likely to consume rather than save. For instance, if the MPC is 0.90, it means that for every additional dollar earned, the household will spend 90 cents and save the remaining 10 cents.

MPC is a crucial factor in determining the multiplier effect in an economy, which we will discuss further in the economic multipliers' section. By understanding a household's MPC, policymakers can predict consumer spending behaviors in response to changes in income, facilitating more effective fiscal policy decisions.

Similar to the concept of MPC, the Marginal Propensity to Invest (MPI) is a measure of the fraction of additional income that businesses are expected to invest. The MPI value can vary based on several factors, including business confidence and access to capital. If businesses are optimistic about the future, they are likely to invest a larger proportion of additional income, which can lead to economic growth.

In the provided exercise, different MPI values, along with the corresponding MPC values, are used to calculate the spending multiplier. Understanding MPI helps in assessing the overall impact investments have on the economy and aids in establishing more accurate economic forecasting.

Fiscal policy involves government spending and taxation decisions that influence the level of aggregate demand in the economy. It is a powerful tool that policymakers use to regulate economic performance, aiming to achieve sustainable growth, low unemployment, and stable inflation.

When the government implements fiscal policy, it affects the MPC and MPI. Tax cuts could lead to higher disposable income for households and companies, which may increase both consumption and investment levels. On the other hand, increased government spending directly contributes to aggregate demand and can stimulate economic activity. The efficacy of fiscal measures partly relies on the spending and investing behavior of agents in the economy, which in turn influences the overall spending multiplier.

Economic multipliers capture the ripple effect of a change in economic activity. Specifically, they measure how GDP is expected to increase as a result of an increase in spending. The spending multiplier is particularly important as it quantifies the impact of additional investment or consumption on the total economic output.

The formula to calculate the spending multiplier is given by \( 1 / (1 - MPC + MPI) \). As seen in the solution to the exercise, the spending multiplier varies depending on the MPC and MPI. A higher MPC or MPI would typically result in a larger multiplier effect, indicating that each dollar spent by the government or invested by businesses has a greater impact on the overall economy. This is vital information for crafting and adjusting fiscal policy, as it helps predict the potency of such interventions.