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Spending and Tax Multipliers
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If the government increases spending by $100 million and the marginal propensity to save (MPS) is 0.2, what is the expected increase in aggregate demand?

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Choose the Best Answer

A

$500 million

B

$400 million

C

$100 million

D

$800 million

Understanding the Answer

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Answer

When the government increases spending by $100 million, it puts more money into the economy. This extra money allows people and businesses to buy more goods and services, which increases overall demand. The marginal propensity to save (MPS) is 0. 2, meaning that people save 20% of any extra income they receive and spend 80%. To find the total increase in aggregate demand, we first calculate the spending multiplier, which is 1 divided by the MPS.

Detailed Explanation

When the government spends money, it creates more income for people. Other options are incorrect because This answer might come from thinking that the multiplier effect is smaller; This option suggests that spending has no effect, which is incorrect.

Key Concepts

Spending Multiplier
Marginal Propensity to Save
Aggregate Demand
Topic

Spending and Tax Multipliers

Difficulty

hard level question

Cognitive Level

understand

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