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1. (a) Define the marginal propensity to consume and explain its role in determining the size of the multiplier.
The marginal propensity to consume indicates the proportion of a change in disposable income that is used for consumption. The formula is: Marginal Propensity to consume = change in consumption expenditure / change in disposable income. The greater the marginal propensity to consumer is, the greater the value of the multiplier will be.
(b) Explain how the size of the multiplier will change when one brings in the role Of imports.
Imports make the multiplier smaller when the effect of imports in included in the calculation. This is because by including imports means that the marginal propensity to import is also being included.
(C) Using the concepts in parts (a) and (b) above, calculate the slope of the AE curve and the size of the multiplier if MPC = 0.80. Then, calculate the revised slope of the AE curve and the multiplier when you know that the marginal propensity to import is 0.15 and the marginal tax rate (induced tax rate) is 0.2.
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