An increase in the MPC

Question

BlackTom AI · Accepted Answer

Starting from the relationship between marginal propensity to consume (MPC) and the fiscal multiplier helps us evaluate each choice. When MPC rises, the spending pulse from a given change in autonomous spending gets amplified more as households consume a larger portion of any income they receive.
Option 1: 'increases the multiplier, so that changes in government expenditures have a smaller effect on aggregate demand.' This is incorrect because a higher MPC actually amplifies the impact of spending on aggregate demand, not dampens it. A larger fraction of additional income is spent, so the total effect is bigger, not smaller.
Option 2: 'increases the multiplier, so that changes in government expenditures have a larger effect on aggregate demand.' This aligns with the basic multiplier logic: the multiplier ≈ 1/(1 − MPC). As MPC rises, the denominator shrinks, the multiplier grows, and each dollar of government spending yields a bigger increase in aggregate demand. This option correctly captures the relationship.
Option 3: 'decreases the multiplier, so that changes in government expenditures have a smaller effect on aggregate demand.' This would be true if MPC fell, not risen. Since we’re told MPC increases, this statement contradicts the mathematical link between MPC and the multiplier, making it false.
Option 4: 'decreases the multiplier, so that changes in government expenditures have a larger effect on aggregate demand.' This combines an incorrect claim (decrease in the multiplier) with an effect (larger). The two parts are inconsistent with the standard multiplier formula, so this option is ruled out.
In summary, the only option that coherently reflects the effect of a higher MPC on the fiscal multiplier is Option 2, which states that the multiplier increases and government expenditure changes have a larger impact on aggregate demand.

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