The Impact of Marginal Propensity to Save on Equilibrium Expenditure

Understanding the Relationship Between Marginal Propensity to Save and Equilibrium Expenditure

An economy with no imports and no taxes is operating under simplified conditions where the focus is on analyzing the impact of autonomous expenditure on equilibrium expenditure. In this scenario, the key factor to consider is the marginal propensity to save (MPS), which plays a crucial role in determining the multiplier effect.

The Marginal Propensity to Save: The marginal propensity to save refers to the proportion of an increase in income that households choose to save rather than spend. In this case, let's assume the marginal propensity to save is 0.20, which means that 20% of any additional income earned will be saved.

The Multiplier Effect:

The multiplier effect measures the impact of an initial change in spending on the overall economy. It reflects the magnifying effect that an initial increase in autonomous expenditure has on equilibrium expenditure.

Now, let's analyze the given scenario:

A $10 Billion Increase in Autonomous Expenditure: According to the information provided, a $10 billion increase in autonomous expenditure will lead to an equilibrium expenditure increase of $60 billion. This implies that the multiplier for this economy is 5.

Calculating the Multiplier Value:

Since the Marginal Propensity to Save (MPS) is 0.20, the Marginal Propensity to Consume (MPC) is 1 - 0.20 = 0.80. Therefore, the multiplier can be calculated as follows:

Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.80) = 1 / 0.20 = 5

Impact of a $60 Billion Increase in Autonomous Spending:

If autonomous spending increases by $60 billion, the equilibrium expenditure will experience a significant boost. Let's calculate the effect using the multiplier:

Equilibrium Expenditure Increase = Autonomous Expenditure Increase x Multiplier

Equilibrium Expenditure Increase = $60 billion x 5 = $300 billion

Conclusion:

In conclusion, the multiplier value for this economy is 5, resulting in a $60 billion increase in autonomous spending leading to a $300 billion increase in equilibrium expenditure. The correct answer corresponds to option C, which is $48 billion; 1.25, highlighting the essential role played by the Marginal Propensity to Save in determining the multiplier effect.

Question:

What is the impact of a $60 billion increase in autonomous spending on equilibrium expenditure when the marginal propensity to save is considered?

Answer:

The $60 billion increase in autonomous spending would result in a $300 billion increase in equilibrium expenditure in an economy with no imports and no taxes, and a marginal propensity to save of 0.20.