Assume exports increase by $500 million and imports decrease by $300 million and that the MPC is 0.75. What's the effect on GDP?

There are a couple ways to approach this question. Here's one way to think about it. 

GDP can be calculated with this formula: Y = C + I + G + (X-IM), where Y = GDP, C = consumption (goods purchased by consumers), I = investment, G = government spending, X = exports and IM = imports. For the purposes of your question, C (consumption), I (investment) and G (government spending) are all staying the...

There are a couple ways to approach this question. Here's one way to think about it. 

GDP can be calculated with this formula: Y = C + I + G + (X-IM), where Y = GDP, C = consumption (goods purchased by consumers), I = investment, G = government spending, X = exports and IM = imports. For the purposes of your question, C (consumption), I (investment) and G (government spending) are all staying the same, so our simplified formula looks like this: Y = (X-IM).

Change in GDP = change in (X-IM) = 500 million export increase minus a 300 million import decrease = 500-(-300) = $800 million change in GDP

But that's not the whole effect on GDP, because you've also been given the MPC (marginal propensity to consume). The MPC can be used to calculate the multiplier, which is a measure of amplification. Put simply, it's a measure of the ripple effect of a change in GDP. Any change in GDP is amplified by consumer patterns, since income for one person is an expenditure for another person. 

To calculate the real change in GDP, we need to multiply our $800 million by the multiplier. The multiplier is 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4. 

Effect on GDP = 4*$800 million = $3.2 billion increase