📚 Learning Guide
Investment Spending and GDP Change
hard

Arrange the following steps to demonstrate how an increase in investment spending leads to a change in real GDP through the multiplier effect:

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Choose the Best Answer

A

Calculate the marginal propensity to save (MPS).

B

Determine the multiplier using the formula 1/(1-MPC).

C

Identify the initial increase in investment spending.

D

Calculate the total increase in real GDP by multiplying the initial investment increase by the multiplier.

Understanding the Answer

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Answer

When businesses increase their investment spending, they buy more equipment, buildings, or technology. This spending creates jobs and income for workers who build or create these goods, leading to more people having money to spend. As these workers spend their earnings on goods and services, businesses see higher sales and may invest even more to meet the increased demand. For example, if a company invests in new machinery, it might hire more workers, who then spend their wages at local shops. This cycle continues, and the overall economy grows, which is known as the multiplier effect, ultimately leading to an increase in real GDP.

Detailed Explanation

The first step is to identify the initial increase in investment spending. Other options are incorrect because Calculating the marginal propensity to save (MPS) is not the first step; Determining the multiplier comes after knowing the initial investment.

Key Concepts

Investment Spending
Multiplier Effect
Marginal Propensity to Save (MPS)
Topic

Investment Spending and GDP Change

Difficulty

hard level question

Cognitive Level

understand

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