If in an economy a $250 mil increase in investment spending creates
$250 mil in new income in the first round of the multiplier process
and $200 mil in the second round the multiplier and the propensity to
consume will be how much?

Hello.

This is a very basic economics question. Once you understand the
multiplier formula, you should have no trouble solving these
questions.

The formula for the multiplier is: 
M = 1 / (1 - MPC)   [where MPC is the marginal propensity to consume]

You solve a question like this by first calculating the marginal
propensity to consume. Since the first round income was $250 million,
and the second round income was $200 million, the marginal propensity
to consume is:
$200 million / $250 million = 0.80  (In other words, 80% of the income
was consumed in the next round).

Thus the multiplier = 1 / (1-0.80) = 1 / 0.20 = 5

So, there you have it. Multiplier equals 5, while marginal propensity
to consume equals 0.80 .


This question is very similar to Question #5 on the McConnell & Brue
economics self-test:
http://www.mhhe.com/economics/mcconnell/student/stq/chap10.htm

For a full explanation of the multiplier effect, view the section
"What is the multiplier?" on francisferguson.com:
http://www.francisferguson.com/Some_macro_questions_and_answers.htm

search strategy: multiplier, "propensity to consume", "first round",
"second round"

I hope this helps.

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Request for Answer Clarification by down-ga on 31 Oct 2002 05:12 PST

I have compared my answer with yours - it is right
thanks for clarifying that I am on the right track

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Clarification of Answer by juggler-ga on 31 Oct 2002 10:15 PST

If you came up with the same answer, then it sound like you're
definitely on the right track! Solving economics problems such as this
is just a matter of plugging numbers into a formula. Good luck with
your studies.