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WA6. Multiplier Effect and Real GDP Change

Statement

Due to the post pandemic changing scenario there is an economic slowdown, and the only solution is to boost the economy by infusion. The federal government decided to infuse $400000 into the economy for a period of time and see the rolling effect. Calculate the multiplier effect and find out the real GDP change if the multiple propensities to consume is 0.6?

Answer

The marginal propensity to consume (MPC) is a macroeconomic concept that measures the relationship between changes in consumer spending and changes in disposable income. MPC = ΔC/ΔYd, where ΔC is the change in consumption and ΔYd is the change in disposable income (Ansari, 2020).

The multiplier effect is the ratio of the change in real GDP to the initial change in GDP component that caused it. The formula for the multiplier effect is 1/(1-MPC) (Rittenberg & Tregarthen, 2009).

We know that MPC = 0.6 from the problem statement; thus, we can calculate the multiplier effect as follows (Ganti, 2024):

\[ \begin{aligned} \text{Multiplier effect} &= \frac{1}{1 - \text{MPC}} \\ &= \frac{1}{1 - 0.6} \\ &= \frac{1}{0.4} \\ &= 2.5 \end{aligned} \]

The multiplier effect is 2.5, which means that for every dollar spent, the real GDP will increase by $2.5. In other words, the change in GDP is computed as follows (Rittenberg & Tregarthen, 2009):

\[ \begin{aligned} \triangle\text{GDP} &= \text{Multiplier effect} \times \text{Initial change in GDP} \\ &= 2.5 \times \$400000 \\ &= \$1000000 \end{aligned} \]

To conclude, when the federal government infuses $400000 into the economy -in any form-, it increases aggregate demand; the economy receives the boost and starts utilizing it by creating more jobs, increasing production, etc. By end of the period, the $400000 infusion would have been multiplied 2.5 times, resulting in a real GDP growth of $1000000 (Lumen Learning, 2024).

References

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