Q3. An open economy has a marginal propensity to save of 0.3, a marginal propensity to tax of 0.25 and a marginal propensity to import of 0.25.
Using the concept of the multiplier, calculate the final value of GDP increase following an initial cash injection of 2.5 million euros?
Workings
- The multiplier when there are three leakages (Savings, imports and taxation))
- = 1/ the sum of the marginal rate of withdrawal from the circular flow.
- =1/ (MPS + MRT + MPM)
- MPS = 0.3, MRT = 0.25 and MPM= 0.25
- Therefore the sum of the marginal rate of leakage = 0.8
- Therefore the coefficient of the multiplier = 1/0.8 = 1.25
- An injection of 2.5 million euros will lead to a final change in national income 1.25 x 2.5m = 3.1 million euros.
| Q4. 1. Calculate the marginal propensity to save (MPS) for this open economy illustrated in the table below. 2.Calculate the value of the multiplier? 3. How much will the government have to inject into this economy if it wants the economy to operate at its full employment level? | |
| Marginal propensity to consume (MPC) : 0.7 Marginal propensity to import (MPM):0.3 Current equilibrium level of national income: 400 million (€) Level of national income that would give full employment: 520 million (€) |
Workings
- 1.MPS = (1 –MPC) = (1- 0.7) = 0.3.
- 2. The value of the multiplier: 1/1- (0.7 -0.3) = 1/1-0.4 = 1.67 OR 1/(0.3 +0.3) = 1.67
- 3. The shortfall in national income = (520m – 400m)
- =120m/1.67. =71.86 million euros.
- The Government must increase spending by this amount.