If the marginal propensity to save is 0.2 and the government decreases its purchases by $20 billion, then real GDP willDecrease by $100 billion.Increase by $100 billion.Decrease by $25 billion.Increase by $25 billion.
Question
If the marginal propensity to save is 0.2 and the government decreases its purchases by 100 billion.Increase by 25 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 change in real GDP is calculated by multiplying the change in government purchases by the spending multiplier. In this case, the government decreases its purchases by 20 billion * 5 = - $100 billion.
Therefore, the real GDP will decrease by $100 billion.
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