Select Any One Of the Following Options: If the marginal propensity to save is 0.2 and the government decreases its purchases by $20 billion, then real GDP willDecrease by $25 billion.Decrease by $100 billion.Increase by $100 billion.Increase by $25 billion.
Question
Select Any One Of the Following Options: If the marginal propensity to save is 0.2 and the government decreases its purchases by 25 billion.Decrease by 100 billion.Increase by $25 billion.
Solution
The answer to this question can be found by understanding the concept of the spending multiplier in economics. The spending multiplier is the reciprocal of the marginal propensity to save (MPS). In this case, the MPS is 0.2, so the spending multiplier is 1/0.2 = 5.
The spending multiplier tells us how much real GDP will change for a given change in spending. In this case, the government decreases its purchases by $20 billion.
To find the total change in real GDP, we multiply the change in spending by the spending multiplier. So, 100 billion.
Therefore, if the government decreases its purchases by 100 billion. So, the correct option is "Decrease by $100 billion".
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