Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30. the marginal propensity to consume (mpc) for this economy is , and the multiplier for this economy is . suppose the government in this economy decides to decrease government purchases by $300 billion. the decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to . this decreases income yet again, causing a second change in consumption equal to . the total change in demand resulting from the initial change in government spending is .

(a) 0.7

(b) 3.33

(c) -$210

(d) -$147

(e) -$1 trillion

Explanation:

(a) Marginal propensity to consume (MPC) = 0.7

(b) Multiplier of this economy:

      = 3.33

(c) Decrease government purchases by $300 billion,

Initial change in consumption = Change in government purchases × MPC

                                                  = $300 × 0.7

                                                  = -$210 billion

(d) This decreases income yet again, causing a second change in consumption equal to:

= Initial change in consumption × MPC

= -$210 × 0.7

= -$147 billion

(e) The total change in demand resulting from the initial change in government spending is:

= Change in government purchases × Multiplier

= $300 × 3.33

= -$1 trillion

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