An economy has a marginal propensity to save of 0.2 and a marginal propensity to import of 0.1. An increase of $1 billion in government spending now occurs. (Hint: Assume that the economy is initially producing at a level that is below its supply-side capabilities.)
a. According to the spending multiplier for a small open economy, by how much will domestic product and income increase?
b. If instead this were a closed economy with a marginal propensity to save of 0.2, by how much would domestic product and income increase if government spending increased by $1 billion? Explain the economics of why this answer is different from the answer to part a.