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MPS, MPC and Spending Multiplier: How to calculate

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Given that the marginal propensity to consume (MPC) is .875:

(1) What is the marginal propensity to save (MPS)?

(2) Calculate the spending multiplier.

(3) If the government stimulates the economy via new spending of $150 million:

(a) What is the total projected spending that this could generate throughout the economy?
(b) What incremental spending would be generated?

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Solution Preview

1. MPS = 1 - MPC = 1 - 0.875 = 0.125

2. Spending Multiplier = 1/MPS = 1/0.125 ...

Solution Summary

Given an economy's Marginal Propensity to Consume (MPC), this solution shows how to calculate the economy's Marginal Propensity to Save (MPS), Spending Multiplier (SM), and the total and incremental increase in spending in the economy that results from an increase in government spending. All formulas and calculations are given in full.

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The economy of Alphaland is represented by the following:
C= 50 +0.25Yd
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(d) If the government increases taxes and spending by 50 what is the new equilibrium level of output?
(e) Calculate the equilibrium level of output in case where taxes depend on income according to the following: T=-25+0.125Y.

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