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Chapter 21: Problem 2

The spending multiplier is defined as a. \(1 /(1-\) marginal propensity to consume) b. \(1 /\) (marginal propensity to consume). c. \(1 /(1-\) marginal propensity to save). d. \(1 /\) marginal propensity to consume \(+\) marginal propensity to save).

Short Answer

Expert verified
The correct definition of the spending multiplier is \[ 1 / (1 - \text{marginal propensity to consume}) \]. Therefore, the answer is option a.

Step by step solution

01

Analyzing option a.

Option a presents the equation as: \[ 1 / (1 - \text{marginal propensity to consume}) \] This equation corresponds to the correct definition of the spending multiplier, which represents the multiplied effect of an initial increase in spending. The factor multiplying initial spending is the reciprocal of the marginal propensity to save, which can be expressed as the complement of the marginal propensity to consume (since MPC + MPS = 1).
02

Analyzing option b.

Option b presents the equation as: \[ 1 / \text{marginal propensity to consume} \] This equation does not properly represent the spending multiplier, as it does not consider the dramatic effect the initial change in spending has on the whole economy. The correct formula should consider the reciprocal of the 'marginal propensity to save' or its equivalent in terms of the 'marginal propensity to consume.'
03

Analyzing option c.

Option c presents the equation as: \[ 1 / (1 - \text{marginal propensity to save}) \] This equation does not correctly define the spending multiplier since it is not directly related to the marginal propensity to consume. The right expression should be based on the complement of the marginal propensity to consume, as mentioned in the analysis of option a.
04

Analyzing option d.

Option d presents the equation: \[ 1 / (\text{marginal propensity to consume} + \text{marginal propensity to save}) \] Although the equation seems to be potentially correct at first glance, as it includes both the MPC and MPS, it should use the complement of the marginal propensity to consume in the denominator, not the sum. The spending multiplier is based on the cumulative effects of the initial change in expenditure, not the effect of individual components added together. So this option doesn't correctly represent the spending multiplier. Based on the analysis of all four options, the correct definition of the spending multiplier is:
05

Correct definition of spending multiplier

The spending multiplier is defined as: \[ 1 / (1 - \text{marginal propensity to consume}) \] This means, the correct answer is option a.

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Most popular questions from this chapter

If no fiscal policy changes are implemented, suppose the future aggregate demand curve will shift and exceed the current aggregate demand curve by \(\$ 900\) billion at any level of prices. Assuming the marginal propensity to consume \((M P C)\) is \(0.90,\) this increase in aggregate demand could be prevented by a. increasing government spending by \(\$ 500\) billion. b. increasing government spending by \(\$ 140\) billion. c. decreasing taxes by \(\$ 40\) billion. d. increasing taxes by \(\$ 100\) billion.

Contractionary fiscal policy is deliberate government action to influence aggregate demand and the level of real GDP through a. expanding and contracting the money supply. b. encouraging business to expand or contract investment. c. regulating net exports. d. decreasing government spending or increasing taxes.

Mathematically, the value of the tax multiplier in terms of the marginal propensity to consume \((M P C)\) is given by the formula a. \(M P C-1\) b. \((M P C-1) / M P C\) c. \(1 / M P C\) d. \(1-[1 /(1-M P C)]\)

If no fiscal policy changes are implemented, suppose the future aggregate demand curve will exceed the current aggregate demand curve by \(\$ 500\) billion at any level of prices. Assuming the marginal propensity to consume \((M P C)\) is 0.80 this increase in aggregate demand could be prevented by a. increasing government spending by \(\$ 500\) billion. b. increasing government spending by \(\$ 140\) billion. c. decreasing taxes by \(\$ 40\) billion. d. increasing taxes by \(\$ 125\) billion.

The marginal propensity to save is a. the change in saving induced by a change in consumption. b. (change in \(S\) ) / (change in \(Y\) ). c. \(1-M P C / M P C\) d. (change in \(Y-b Y\) ) / (change in \(Y\) ). e. \(1-M P C\)
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