When an economy is operating well below its full-employment capacity and the marginal propensity to consume is 3/4, a $10 billion increase in investment will cause the equilibrium income to rise by
A) $5 billion.
B) $10 billion.
C) $20 billion.
D) $40 billion.

Question

Quizplus · Accepted Answer

The multiplier effect is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume. Here, MPC is 3/4, so the multiplier is 1/(1-0.75) = 4. Therefore, a $10 billion increase in investment will increase the equilibrium income by 4 * $10 billion = $40 billion.

When an Economy Is Operating Well Below Its Full-Employment Capacity