Question

At various times in the past-the early $1980$ s, early $1990$ s, early $2000$ s, and late $2000$ s-business profit expectations plummeted, and firms cut back on their investment spending. The ratio of total investment spending to companies' aggregate profit flows decreased markedly. In each instance, real GDP declined, and the U.S. economy fell into recession. At the end of the recession intervals of the early $1980$ s, early$1990$ s, and early $2000$ s, business profit expectations improved. Firms responded by boosting their investment spending, and both real GDP and the ratio of investment expenditures to firms' profits recovered fully. At the conclusion of the late-$2000$s recession, however, this ratio failed to return to its previous level. By the time you have completed this chapter, you will understand why the result during this current decade has been a sluggish improvement in real GDP and, hence, an unusually slow economic recovery.

Evaluate why autonomous changes in total planned expenditures have a multiplier effect on equilibrium real GDP

Short answer

Because of the multiplier effect, a change in autonomous consumption will lead to a far greater change in real GDP in the end. In the end, the impact of such spending on real GDP will be much bigger.

Step-by-step solution

Evaluate to calculate multiplier

Formula to calculate multiplier:

Multiplier $=\frac{1}{1-MPC}$

Where,

Marginal Propensity to Consume is represented by MPC.

Calculate Multiplier when Marginal Propensity to Save MPS $=0.25:$

Multiplier $=\frac{1}{1-MPC}$

$=\frac{1}{1-MPC}\left(\begin{array}{l}\because MPC+MPS=1\\ MPC=1-MPS\end{array}\right)$

$=\frac{1}{1-(1-MPS)}$

localid="1651510049200" $=\frac{1}{1-1+MPS}$

$=\frac{1}{MPS}$

$=\frac{1}{0.25}$

Multiplier $=4$

Therefore, multiplier is$4$

Marginal propensity to Consume 

Multiplier is calculated when the marginal propensity to consume MPC is high. $=\frac{5}{6}$:

Multiplier $=\frac{1}{1-MPC}$

$=\frac{1}{1-\left({\displaystyle \frac{5}{6}}\right)}$

$=\frac{1}{\left({\displaystyle \frac{6-5}{6}}\right)}$

$=\frac{1}{\left({\displaystyle \frac{1}{6}}\right)}$

$=\frac{1}{1}\times \frac{6}{1}$

$=\frac{6}{1}$

Multiplier $=6$

Therefore, multiplier is $6$

Marginal Propensity to save

Calculate Multiplier when Marginal Propensity to Save MPS $=0.125:$

Multiplier $=\frac{1}{1-MPC}$

$=\frac{1}{1-MPC}\left(\begin{array}{l}\because MPC+MPS=1\\ MPC=1-MPS\end{array}\right)$

$=\frac{1}{1-\left(1-MPS\right)}$

$=\frac{1}{1-1+MPS}$

$=\frac{1}{MPS}$

$=\frac{1}{0.125}$

Multiplier $=8$

Therefore, multiplier is$8$

Marginal Propensity to Consume 

Multiplier is calculated when the marginal propensity to consume MPC is high. $=\frac{6}{7}$:

Multiplier $=\frac{1}{1-MPC}$

$=\frac{1}{1-\left({\displaystyle \frac{6}{7}}\right)}$

$=\frac{1}{\left({\displaystyle \frac{7-6}{7}}\right)}$

$=\frac{1}{\left({\displaystyle \frac{1}{7}}\right)}$

$=\frac{1}{1}\times \frac{7}{1}$

$=\frac{7}{1}$

Multiplier $=7$

Therefore, multiplier is $7$