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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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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