Question

By how much will GDP change if firms increase their investment by $8 billion and the MPC is 0.80? If the MPC is 0.67?

Short answer

GDP will change by $40 billion if MPC is 0.80.

GDP will change by $24.24 billion if MPC is 0.67.

Step-by-step solution

Step 1. Calculation for a change in GDP at MPC equal to 0.80

Change in GDP is induced by a difference in the investment in proportion or multiple times the change in investment. The change in GDP depends on the consumption level in the economy. If the total spending is consumed more and saved less, the difference in income will be more prominent following the multiplier effect.

Given that increase in investment is $8 billion and MPC is 0.8, the increase in GDP can be calculated as follows:

$$\begin{gathered} k=\frac{1}{1-MPC} \\ =\frac{1}{1-0.8} \\ =5 \end{gathered}$$

$$\begin{gathered} ∆GDP=k\times ∆Investment \\ =5\times 8billion \\ =\$40billion \end{gathered}$$

Thus, the GDP will increase by $40 billion.

Step 2. Calculation for change in GDP at MPC equal to 0.67

When MPC is 0.67, the change in GDP is as follows:

$$\begin{gathered} k=\frac{1}{1-MPC} \\ =\frac{1}{1-0.67} \\ =0.03 \end{gathered}$$

$$\begin{gathered} ∆GDP=k\times ∆Investment \\ =3.03\times \$8billion \\ =\$424.24billion \end{gathered}$$

The GDP will increase by $24.24 billion.