'2. The multiplier effect of . change in government purchases Consider hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30_ The marginal propensity to consume (MPC) for this economy is and the spending multiplier for this economy is Suppose the government in this economy decides to decrease government purchases by $300 billion_ The decrease in government purchases will lead to decrease in income generating an initial change in consumption equal This decreases income yet again_ causing second change in consumption equal to The total change in demand resulting from the initial change in government spending is'
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70. This means that for every additional dollar earned, households will spend $0.70 and save $0.30. The spending multiplier for this economy is calculated as 1/(1-MPC), which is 1/(1-0.70) = 3.33. This means that for every dollar the government spends, total Show more…
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