Assume an increase in investment spending by $100, and a marginal propensity to consume (MPC) of 0.6. How much would GDP increase after the $100 was absorbed by the economy due to the multiplier effect

The increase in GDP is $250

Explanation:

The increase in investment spending = $100

Marginal propensity to consume = 0.6

Now we have to find an increase in the GDP after absorbing the $100.

Therefore, we need to find the multiplier by using the marginal propensity to consume.

Multiplier = 1 / (1-MPC)

Multiplier = 1/( 1- 0.6)

Multiplier = 2.5

The increase in GDP = increase in investment spending × Multiplier

The increase in GDP = 100 × 2.5 = $250

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