Economics · How the macroeconomy works: AD/AS · 6 marks
An economy has a marginal propensity to save of 0.2, a marginal rate of tax of 0.25 and a marginal propensity to import of 0.15. (a) Calculate the value of the multiplier. [2] (b) Government spending rises by £4 billion. Calculate the eventual change in real GDP, and explain one reason the actual change may be smaller. [4]
Mark scheme
- (a) MPW = 0.2 + 0.25 + 0.15 = 0.6
- (a) k = 1/0.6 = 1.67 (to 3 s.f.)
- (b) ΔGDP = 1.67 × £4bn = £6.67bn
- (b) Near full capacity the rise in AD raises the price level rather than output
- (b) Crowding out: government borrowing raises interest rates and reduces private investment
- (b) The multiplier takes time to work through, so the full effect is not seen within the period
Use MPW, not 1 − MPC, whenever tax and imports are given — forgetting the leakages inflates the multiplier badly. Any one valid reason earns the explanation marks in (b).