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Assume a simple, closed economy with no government
Assume a simple, closed economy with no government. The marginal propensity to consume (mpc)=0.8. Assume that firms expect the future sales and profits to fall, and they suddenly cut back (unintended) investment spending by 50 million. By how much will output eventually fall? B. Now assume the same as above, except that now the mpc=0.9. How much will output fall when investment spending drops by 50 million? C. Explain what the mpc value of 0.8 in part A above tells us about consumption.
Expert Solution
The mpc value of .8 tells us that each dollar change in the overall economy will change consumption by a factor of .8 or 80 percent. (A) If $50 million is withdrawn from the economy's spending, the output will fall by 80 percent of 50 million, or 40 million. (B) If $50 million is withdrawn from the economy and the mpc = .9, then output will fall by 90 percent, or 45 million. (C)In a simple closed economy with no government, the remaining 20% (100 -.8) will be the marginal propensity to save, or mps.
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