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sept 2010 q 13

K

kika258

Member
Q13 In an open economy with a government sector, the marginal propensity to consume is 0.75 and the marginal propensity to import is 0.25. The open economy multiplier will equal:
A 4
B 2
C 1
D 1.33

Why is the answer B?

Isn't the equation for the multiplier k=1/1-mpc ie k=1/0.25 = 4?

What am i missing?

Thanks!
 
Hello Kika258

I am no expert on the matter, but I think that the answer to this is because to calculate the multiplier, you must use the marginal propensity to consume domestically produced goods. This is to say, the marginal propensity to consume minus the marginal propensity to import (C-M).

To answer the question: 1 / (1 - (0.75-0.25) ) = 2

You might find it useful to read my post on Marginal Propensity to xxxxxxx (which also goes to some way in explaining why this is (but in the words of the professionals)) AND most importantly, how (I think) this style of question will not come up in the pending examination!!!
 
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