Question

Assume that the economy is at equilibrium at $10 trillion, with a marginal propensity to consume of 0.75. If exports rise by $0.5 trillion and imports increase by $0.7 trillion, equilibrium income will: a. fall by $0.2 trillion. b. not change. c. fall by $0.8 trillion. d. rise by $2 trillion.'

Answer 1

Option (c) is correct.

Step-by-step explanation:

Multiplier effect = 1 ÷ (1 - marginal propensity to consume)

= 1 ÷ (1 - 0.75)

= 4

Net exports = Exports - Imports

= 0.5 - 0.7

= (-0.2)

Impact on the equilibrium income = Net exports × Multiplier effect

= (-0.2) × 4

= (-0.8),

so, the equilibrium income will fall by $0.8 trillion.