Question

At an initial point on the aggregate demand carve, the price level is$100$, and real GDP is$\backslash (18$trillion. After the price level rises to$110$ , however, there is an upward movement along the aggregate demand curve, and real GDP declines to$\mathrm{Sl}4$ trillion. If total planned spending declined by $\backslash )200$ billion in response to the increase in the price level, what is the marginal propensity to consume in this economy?

Short answer

Marginal propensity to consume and the level of real GDP.And the demand curve which shows the inverse relation .

Step-by-step solution

The total demand.

Aggregate demand states the total demand for all services and products in the entire economy. In the closed economy, it comprises of consumption expenditure ($C)$, investment expenditure $\left(I\right)$, government expenditure $\left(G\right)$. But in the open economy, it, not only includes these but also exports ($E$) and imports ($M)$.

Mathematically, it can be expressed as$Y=C+I+G+X-M$

The real GDP diagram.

The following diagram depicts the real GDP and price level in the economy as shown below.

Initially, the price level is $100$and real GDP is $\$18$trillion but when the price level rises to $110$, the real GDP falls to$\$14$ trillion. There will be an upward movement along the demand curve which shows the inverse relation between price level and real GDP.

Marginal propensity to consume.

Marginal Propensity to Consume is the amount of change in consumption due to change in income level. It can also be written as MPC.

The planned spending reduced by$\$200$billion so the change in consumption will be $\$200$billion (or $0.20trillion$) and change in real GDP/Income will be$\$4$trillion.

Therefore, MPC can be computed as shown below:

$MPC=\frac{\partial C}{\partial Y}$

$=\frac{0.20}{4}$

$=0.05$

Hence, the value of MPC is$\mathbf{0}\mathbf{.}\mathbf{05}$.