If short-run equilibrium output equals 10,000, the income-expenditure multiplier equals 5, the mpc equals 0.8, and potential output (Y*)equals 9,000, then transfers must be ________ by approximately ________ to eliminate any output gap.
A)decreased; 250
B)decreased; 200
C)increased; 250
D)increased; 200

Question

Quizplus · Accepted Answer

There is an expansionary gap of 1,000, the amount by which equilibrium output exceeds Y*. An mpc of 0.8 means that households will reduce autonomous spending by only 80 percent of any decrease in transfers. To close the output gap, autonomous expenditure must decrease by 1,000 / 5 = 200, so the decrease in transfers that is needed is 200 / 0.80 = 250.

If Short-Run Equilibrium Output Equals 10,000, the Income-Expenditure Multiplier Equals