Question

In an economy, the increase in income is five times the increase in investment expenditure. Calculate the value of MPC.

Hint:

Multiplier and MPC are related as \(k = \frac{1}{1-MPC}\). A higher MPC results in a larger multiplier effect in the economy.

Answer 1

Step 1: Identify the concept used.
The relationship between the change in income and change in investment is explained through the investment multiplier. The multiplier shows how much income increases due to an increase in investment.
Step 2: Write the formula of multiplier.
The formula for multiplier is:
\[ k = \frac{\Delta Y}{\Delta I} \]
where \(k\) is the multiplier, \(\Delta Y\) is the change in income, and \(\Delta I\) is the change in investment.
Step 3: Use the information given in the question.
It is given that the increase in income is five times the increase in investment. Therefore:
\[ k = 5 \]
Step 4: Use the relationship between multiplier and MPC.
The multiplier is also expressed as:
\[ k = \frac{1}{1 - MPC} \]
Step 5: Calculate MPC.
Substituting \(k = 5\):
\[ 5 = \frac{1}{1 - MPC} \] \[ 1 - MPC = \frac{1}{5} \] \[ MPC = 1 - \frac{1}{5} \] \[ MPC = \frac{4}{5} = 0.8 \] Thus, the value of MPC is \(0.8\).