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Question 1 of 5

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What is the formula for the spending multiplier?

The multiplier formula is 1 / (1 - MPC). This can also be written as 1 / MPS.
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Suppose MPC = 0.8. What is the value of the spending multiplier?

The multiplier formula is 1 / (1 - MPC). If MPC = 0.8, 1 - MPC = 0.2, and MPS = 1 / 0.2 = 5.
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Suppose the government decides to increase spending by $1000. If the multiplier = 5, by how much does equilibrium GDP increase? $

Equilibrium GDP rises by more than the amount of initial spending—the multiplier effect. This is calculated by taking the multiplier times the amount of initial spending. Here, increase in equilibrium GDP = 5 × $1,000 = $5,000.
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Suppose MPC = 0.667. What is the value of the spending multiplier? Round the answer to two or fewer decimal places.

The multiplier formula is 1 / (1 - MPC). If MPC = 0.667, 1 - MPC = 0.333, and spending multiplier = 1 / 0.333 = 3.
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Suppose the government decides to decrease spending by $2,000. If the multiplier = 3, by how much does equilibrium GDP decrease? $

Equilibrium GDP falls by more than the initial cut in spending. This is calculated by taking the multiplier times the initial spending cut. Here, decrease in equilibrium GDP = 3 × $2,000 = $6,000.
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