The Impact of Investment Spending on Real GDP in Villagestan

Explanation:

The Multiplier Effect and Investment Spending: The multiplier effect is a vital concept in economics that illustrates how changes in spending can have a magnified impact on the overall economy. In the case of Villagestan, where there are no imports and income taxes, an increase in investment spending can lead to a significant boost in real GDP.

Marginal Propensity to Consume (MPC): The MPC of 0.8 in Villagestan indicates that for every additional unit of income earned, 80% of it is typically spent by consumers on goods and services, while the remaining 20% is saved. This high MPC signifies a strong consumer spending behavior in the economy.

Calculation of New Real GDP: To determine the impact of a 15 million increase in investment spending on real GDP, we can utilize the multiplier effect formula: 1/(1-MPC). In this case, it becomes 1/(1-0.8) = 5. Therefore, the 15 million investment increase would lead to a GDP rise of 15 million x 5 = 75 million.

Consequently, the new level of real GDP for Villagestan after the investment spending of 15 million would be calculated as follows:

Current Real GDP: 190 million

Increased GDP due to investment: 75 million

New Real GDP = 190 million + 75 million = 265 million

This substantial increase in real GDP highlights the significant multiplier effect in action, showcasing how a relatively small change in investment spending can lead to a much larger impact on the overall economic output of Villagestan.

For a more in-depth explanation of the multiplier effect and its implications, you can explore further resources on the topic here.