The Prime Minister of Richlandia hires you as an economic consultant. He is concerned that the output level in Richlandia is too low and that this will cause unemployment to rise. He feels that it is necessary to increase output by $20 billion. He tells you that the MPC in Richlandia is 0.75. Which of the following would be the best advice to give to the Richlandian Prime Minister?

Question

Quizplus · Accepted Answer

To increase output in Richlandia, the government can use expansionary fiscal policy. This involves increasing government purchases or reducing taxes, which will lead to an increase in aggregate demand and hence output.

To determine the amount of fiscal stimulus needed, we can use the formula:

ΔY = (1/MPS) x ΔG

Where ΔY is the increase in output, MPS is the marginal propensity to save (which is equal to 1 - MPC), and ΔG is the increase in government purchases.

Substituting in the values given:

$20 billion = (1/0.25) x ΔG

ΔG = $5 billion

Therefore, the best advice to give to the Richlandian Prime Minister is to increase government purchases in Richlandia by $5 billion.

The Prime Minister of Richlandia Hires You as an Economic