Consider two economies,A and B.Economy A has a marginal propensity to consume of 0.9,a net tax rate of 0.2 and a marginal propensity to import of 0.2.Economy B has a marginal propensity to consume of 0.7,a net tax rate of 0.2 and a marginal propensity to import of 0.2.Suppose there is an increase in autonomous investment of $5 billion in each of these economies.Which of the following statements is true?
A)There is a larger decrease in real GDP in Economy B as a result of the change in autonomous investment.
B)There is a larger decrease in real GDP in Economy A as a result of the change in autonomous investment.
C)There is a larger increase in real GDP in Economy B as a result of the change in autonomous investment.
D)There is a larger increase in real GDP in Economy A as a result of the change in autonomous investment.
E)There is an equal effect on real GDP in Economies A and B as a result of the increase in autonomous investment.

Question

Quizplus · Accepted Answer

To determine the effect on real GDP in each economy, we need to calculate the multiplier effect of the increase in autonomous investment. The multiplier for both economies can be calculated using the formula:

Multiplier = 1 / (1 - MPC + MPI)

where MPC is the marginal propensity to consume and MPI is the marginal propensity to import.

For Economy A,
Multiplier = 1 / (1 - 0.9 + 0.2) = 2.22

For Economy B,
Multiplier = 1 / (1 - 0.7 + 0.2) = 2.78

Therefore, the increase in autonomous investment of $5 billion will increase real GDP by $11.1 billion in Economy A (2.22 * $5 billion) and $13.9 billion in Economy B (2.78 * $5 billion).

Since both economies have the same increase in autonomous investment and net tax rate, the difference in the multiplier is what causes the difference in the effect on real GDP. Economy B has a higher multiplier due to its higher marginal propensity to consume, which means that it has a larger effect on real GDP. Therefore, the correct answer is D) There is a larger increase in real GDP in Economy A as a result of the change in autonomous investment.

Consider Two Economies,A and B