Question

If the multiplier is 5 and investment increases by \(3 billion, equilibrium real GDP will increase by

1. \)2 billion.

2. \(3 billion.

3. \)8 billion.

4. $15 billion.

Short answer

Option (d): $15 billion

Step-by-step solution

Step 1. Relation between the multiplier and real GDP

The multiplier measures the multiple increases in the income of an economy due to a change in a spending component like an investment. For example, an increase in investment has indirect effects on consumption, exports, and other spending components of GDP, resulting in a greater change in income. The income does not increase only because of investment increase but because of other components as well.

The multiplier (k) is related to change in income or real GDP in the following manner:

Change in investment (𝛥I) × k = Change in income (𝛥Y)

Step 2. Calculation for change in real GDP

k = 5

𝛥I = $3 billion

𝛥Y = 5 × $3 billion

𝛥Y = $15 billion

Therefore, the equilibrium real GDP will increase by $15 billion.