If the marginal propensity to consume is 4/5, then a decrease in government spending of $1 billion decreases the demand for goods and services by $5 billion.

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is the proportion of an additional dollar of household income that is used for consumption. If the MPC is 4/5, it means that for every dollar decrease in income, consumption decreases by 80 cents. The multiplier effect, calculated as 1/(1-MPC), in this case, is 1/(1-4/5) = 5. Therefore, a $1 billion decrease in government spending would decrease the demand for goods and services by 5 times that amount, or $5 billion, due to the multiplier effect.

If the Marginal Propensity to Consume Is 4/5, Then a Decrease