ACCA BT · Chapter 3 · Question 9 of 11
In an open economy, the marginal propensity to save is 0.15, the marginal rate of taxation is 0.06 and the marginal propensity to import is 0.04. The government increases its spending by $30 million. By how much will national income eventually increase?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) $120 million
Explanation
Total marginal propensity to withdraw = 0.15 + 0.06 + 0.04 = 0.25. The multiplier = 1 / 0.25 = 4. The increase in national income = $30 million x 4 = $120 million. Using only the savings ratio gives a multiplier of 1 / 0.15 = 6.67 and $200 million, which ignores taxes and imports; $37.5 million wrongly divides by 0.8; $750 million wrongly divides the spending by the withdrawal rate of 0.04.
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