MPC What is initial impact on real GDP? & What is the value of the total impact on Real GDP?

Question

Macroeconmics Fiscal Policy:

Assume the MPC is 0.70. If the government increases spending on schools by $20 billion, what is the value of the initial impact on real GDP? What is the value of the total impact on Real GDP?

Answer 1

To calculate the initial and total impact on real GDP due to an increase in government spending on schools, we can use the concept of the expenditure multiplier. The expenditure multiplier represents the ratio of the change in real GDP to the initial change in government spending. It is calculated as the reciprocal of the marginal propensity to consume (MPC).

Given:

1. MPC (Marginal Propensity to Consume) = 0.70

Initial Impact on Real GDP:

The initial impact on real GDP is the direct effect of the increase in government spending on schools.

Initial Impact = Change in Government Spending

Initial Impact = $20 billion

Total Impact on Real GDP:

The total impact on real GDP considers both the direct effect of the increase in government spending and the subsequent rounds of spending that result from the initial injection.

The expenditure multiplier (k) is calculated as the reciprocal of the MPC:

𝑘=1/(1-MPC)

Given MPC = 0.70:

𝑘=3.33

The total impact on real GDP is calculated as the product of the initial change in government spending and the expenditure multiplier:

Total Impact = Initial Impact × Expenditure Multiplier

Total Impact = $20 billion × 3.33

Total Impact ≈ $66.6 billion



So, the value of the initial impact on real GDP is $20 billion, and the value of the total impact on real GDP is approximately $66.6 billion.