Question

The marginal propensity to consume is equal to $0.80$. An increase in household wealth causes autonomous consumption to rise by $10$billion. By how much will equilibrium real GDP increase at the current price level. other things being equal?

Short answer

Real GDP will rise by 1% in equilibrium. $50$Other factors being equal, billion at the current price level.

Step-by-step solution

IntroductionStep 1: Calculating the multiplier value

Change in equilibirium real GDP = Multiplier $\times$Change in autonomous spending

We have been provided with the change (increase) in autonomous spending. So, in order to calculate the change (increase) in equilibrium real GDP, we have to first ascertain the value of multiplier.

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

$Multiplier=\frac{1}{1-0.80}$

$Multiplier=5$

Calculating real GDP (increase)

Multiplier $=5$

Change (increase) in autonomous spending$=10$ billion

Change in equilibirium real GDP = Multiplier $\times$ Change in autonomous spending Change (increase) in equilibrium real GDP$=5\times 10$ billion

Change (increase) in equilibrium real GDP$=50$ billion