Question

All else equal, in an open economy, how would an increase in the marginal propensity to import (MPI) affect the government purchases multiplier?

A. It increases the multiplier only if marginal propensity to consume (MPC) is higher than the tax rate.

B. It increases the multiplier only if marginal propensity to consume (MPC) is greater than marginal propensity to import (MPI).

C. It decreases the government purchases multiplier

D. It has no effect

E. it increases the government purchases multiplier

Answer 1

E. it increases the government purchases multiplier

Step-by-step explanation:

Govt multiplier = ΔY/ΔG = 1/(1-mpc*(1-t)+mpi)

All else equal. An increase in mpi will increase the denominator in the above equation. This will reduce the value of RHS. Thus as mpi increases , govt multiplier decreases, because more of the spending is diverted to imports and domestic production doesnot get boost.