How to Increase Real GDP with the Marginal Propensity to Save

What is the impact of the government increasing its purchases of goods and services on real GDP?

A. $25 million.
B. $175 million.
C. $400 million.
D. $2,800 million.

Answer:

Real GDP increases by $400 million.

When the government increases its purchases of goods and services by $100 million with a marginal propensity to save of 0.25 and investment spending at $700 million, the impact on real GDP can be calculated using the multiplier.

The multiplier, which is the reciprocal of the marginal propensity to save (MPS), is calculated as m = 1 / MPS. In this case, the multiplier is 4 because the MPS is 0.25.

The formula to calculate the change in real GDP is m = ΔY / ΔG, where ΔG is the increase in government purchases. By substituting the values, we get ΔY = 4 x $100 million = $400 million.

Therefore, the increase in real GDP due to the government's increase in purchases of goods and services is $400 million.