In a depressed economy with a Marginal Propensity to Consume (MPC) of 0.75, a $100 increase in government spending will have a specific effect on equilibrium GDP. Here's a step-by-step explanation of how this will impact the economy:
1. The Marginal Propensity to Consume (MPC) of 0.75 means that for every additional dollar of income, individuals will spend $0.75 and save $0.25.
2. When the government increases spending by $100, this injection of funds will lead to an increase in aggregate demand in the economy.
3. The initial impact of the increase in government spending will be greater than $100 due to the multiplier effect. The multiplier effect is calculated as 1 divided by the marginal propensity to save (MPS), which is 1 - MPC. In this case, the MPS is 0.25 (1 - 0.75), so the multiplier will be 1 / 0.25 = 4.
4. Therefore, the total increase in equilibrium GDP will be $100 (initial government spending) multiplied by the multiplier of 4, which equals $400.
5. As a result, the equilibrium GDP will increase by $400 in response to the $100 increase in government spending, reflecting the impact of the multiplier effect in the economy.
In summary, in a depressed economy with an MPC of 0.75, a $100 increase in government spending will lead to a $400 increase in equilibrium GDP due to the multiplier effect. This demonstrates how changes in government spending can have a magnified impact on the overall economic output.
