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

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).

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.'

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.

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:

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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