If the marginal propensity to consume is 0.6; full employment income is $500; and the current equilibrium is $750, a(n) _____ gap exists, such that a(n) _____ in spending equal to _____ is needed to close the gap.
A) inflationary; decrease; $100
B) inflationary; decrease; $250
C) recessionary; increase; $100
D) recessionary; increase; $250

Question

Quizplus · Accepted Answer

The current equilibrium ($750) is above the full employment income ($500), indicating an inflationary gap. The spending multiplier is 1/(1-MPC) = 1/0.4 = 2.5. To close the gap of $250, a decrease in spending of $100 is needed ($250/2.5 = $100).

If the Marginal Propensity to Consume Is 0