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If the government increases spending by $5 million and the MPS=.07 by how many million...

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Mizdee | Student, Undergraduate | Valedictorian

Posted October 13, 2012 at 8:09 PM via web

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If the government increases spending by $5 million and the MPS=.07 by how many million dollars will the level of Real GDP increased?

a. $61.3

b. $22.17

c. $71.42

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted October 13, 2012 at 8:27 PM (Answer #1)

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The correct answer here is C.  The increase in government spending that you refer to here will, in the circumstances described, lead to an increase of $71.42 million in real Gross Domestic Product.

This result can be found by using the spending multiplier.  The relevant equation in this case is

Multiplier = 1/marginal propensity to save

In this case, the MPS is .07.  1/.07 gives us 14.286.  Thus the multiplier for any government spending in this situation is 14.286. 

To find the answer to this question, then, we simply calculate $5 million x 14.286.  This gives us $71.42 million.  Therefore, C is the correct answer.

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