How much will GDP change if firms increase their investment by $13 billion and the MPC (marginal propensity to consume) is 0.9?

To calculate the change in GDP resulting from an increase in investment, we need to understand the concept of the spending multiplier. The spending multiplier (also known as the fiscal multiplier) is the ratio of a change in national income to any autonomous change that causes it, such as an increase in investment. It is defined as 1/(1 - MPC), where MPC stands for the marginal propensity to consume.

With an MPC (marginal propensity to consume) of 0.9, the spending multiplier would be calculated as follows:

Spending multiplier = 1 / (1 - MPC) Spending multiplier = 1 / (1 - 0.9) Spending multiplier = 1 / 0.1 Spending multiplier = 10

Now, if firms increase their investment by $13 billion, we can find the total change in GDP by multiplying the increase in investment by the spending multiplier:

Change in GDP = Increase in investment x Spending multiplier Change in GDP = $13 billion x 10 Change in GDP = $130 billion

So, with an MPC of 0.9, a $13 billion increase in investment would lead to a $130 billion increase in GDP.

Extra: The Marginal Propensity to Consume (MPC) is a key economic concept which describes the proportion of additional income that a consumer will spend on goods and services as opposed to saving it. An MPC of 0.9 implies that for every additional dollar received, a consumer will spend 90 cents and save 10 cents.

The importance of the MPC lies in its role in the multiplier effect. The multiplier effect describes how an initial change in spending (like the $13 billion increase in investment in this example) leads to a larger change in economic output. This is because the initial spending creates income for others, who then spend a portion of that income, and so on, leading to a cascading effect throughout the economy. The higher the MPC, the larger the multiplier effect, and the greater the impact on GDP.

Conversely, if the MPC were lower, the spending multiplier would be smaller, and the same increase in investment would result in a less pronounced effect on GDP. Understanding the multiplier effect and the MPC is crucial for economic policy decisions as it helps predict the impact of fiscal policy changes on the economy.