Question

If the marginal propensity to consume \((M P C)\) is \(0.60,\) the value of the spending multiplier is a. 0.4 b. 0.6 c. 1.5 d. 2.5

Short answer

The spending multiplier is calculated using the formula: Spending multiplier = \(1 / (1 - MPC)\). Given the marginal propensity to consume (MPC) is 0.60, we can substitute this value into the formula to find the spending multiplier: Spending multiplier = \(1 / (1 - 0.60)\) = \(1 / 0.40\) = 2.5. Therefore, the correct answer is d. 2.5.

Step-by-step solution

Find the spending multiplier using the formula

We are given that the marginal propensity to consume (MPC) is 0.60. Now we will use the formula for spending multiplier: Spending multiplier = \(1 / (1 - MPC)\)

Substitute the given value of MPC into the formula

Now, we will substitute the given value of MPC (0.60) into the formula: Spending multiplier = \(1 / (1 - 0.60)\)

Calculate the spending multiplier

After substituting the value of MPC, we can calculate the spending multiplier: Spending multiplier = \(1 / (1 - 0.60)\) = \(1 / 0.40\) = 2.5

Choose the correct answer

Now we can compare our calculated spending multiplier (2.5) to the given options: a. 0.4 b. 0.6 c. 1.5 d. 2.5 Our calculated value of the spending multiplier is 2.5, which matches option d. So the correct answer is: d. 2.5

Key concepts

Marginal Propensity to Consume

Marginal Propensity to Consume (MPC) is a foundational concept in economics that measures the proportion of additional income that a household is likely to spend on goods and services, rather than saving it. The concept of MPC is crucial in understanding how economic policies might affect consumer spending and, in turn, the overall economy.

The MPC is represented by a number between 0 and 1. For example, if the MPC is 0.60, it means that for every extra dollar earned, the household is likely to spend 60 cents and save the remaining 40 cents. MPC plays a significant role in determining the strength of the spending multiplier effect, which reflects how initial spending can lead to a greater total impact on national income.

It is important for students to recognize that the MPC can vary across different income levels and demographic groups. This variance can have implications for fiscal policy, such as tax cuts or direct government spending, and how effective these measures might be in stimulating economic activity.

Macroeconomics

Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Within macroeconomics, we consider a broad array of concepts such as inflation, unemployment rates, national income, GDP, and the effects of government policies on the overall economy.

Understanding concepts like MPC within the macroeconomic context helps students to grasp how individual behaviors and preferences aggregate up to affect larger economic outcomes. One focal point in macroeconomics is to analyze how different sectors of the economy respond to changes made by policymakers or external shocks. This field of study aims to assess economic trends and cycles in order to develop and evaluate policies intended to maintain stable prices, full employment, and economic growth.

Fiscal Policy

Fiscal policy refers to government use of spending and taxation to influence the economy. By adjusting its levels of spending and tax rates, the government attempts to promote full employment, maintain a controlled rate of economic growth, and stabilize prices and wages.

When a government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is exercising fiscal policy. The outcome of these decisions can affect the rate of inflation, the employment rate, and the rate of economic growth.

Fiscal policy can be either 'expansionary' or 'contractionary'. Expansionary fiscal policy, typically involving increased government spending or tax cuts, is used to combat unemployment in a recession by increasing overall demand. Contractionary fiscal policy, with reduced government spending or increased taxes, aims to reduce inflation. A clear understanding of how fiscal policy can influence the MPC and spending multiplier allows students to better understand and predict the consequences of government intervention in the economy.