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Assume that the marginal propensity to consume in an economy is 0.8. Autonomous consumption,...

Question:

Assume that the marginal propensity to consume in an economy is 0.8. Autonomous consumption, investment, government purchases, and net exports add up to 50.

a) Can this economy have a GDP of 300? Why not and what would happen if it did?

b) Suppose government purchases increased by 25. What is the new GDP in this economy?

Gross Domestic Product:

The gross domestic product (GDP) equals the dollar value of all final goods and services that are produced within the geographical border of a nation during a specific period of time (i.e., one year).

Answer and Explanation:

a) Let the marginal propensity to consume is c. Then,

{eq}\displaystyle GDP=\frac{C+I+G+NX}{1-c}=\frac{50}{1-0.8}=250 {/eq}

Thus, this economy at the maximum could have $250. To reach a higher level of GDP wither the propensity to consume (c) should increase or other any other components of the GDP such as investment (I), government expenditure (G), or net export (NX).

b) {eq}\displaystyle New \; GDP=\frac{150+25}{1-0.8}=875 {/eq}


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