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If, business investment in the US increased by $155 million and the US MPC was 0.9, the...

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Mizdee | Student, Undergraduate | (Level 1) Valedictorian

Posted October 13, 2012 at 8:02 PM via web

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If, business investment in the US increased by $155 million and the US MPC was 0.9, the increase in business investment caused US GDP to:

a.  decrease by $155 million

b. decrease by $1.55 million

c. increase by $1550 million

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted October 13, 2012 at 8:23 PM (Answer #1)

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The correct answer here is C.  The investment that you describe will, in this situation, lead to an increase of $1.55 billion (which is the same as $1550 million) in gross domestic product.

We can find this by using the multiplier.  The multiplier is found by using the equation

Multiplier = 1/1-marginal propensity to consume

In this case, the MPC is .9.  This means that 1 – MPC is .1.  1/.1 = 10.

So, the multiplier is 10.  This means that an increase in business investment will cause an increase in GDP that is 10 times greater.  An increase of $155 million in business investment will lead to an increase of $1550 million, or $1.55 billion, in GDP.

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