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?
- 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 (€)
- 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.