Real GDP equals $200 billion, the government collects 20% of any increase in real GDP in the form of taxes, and the marginal propensity to consume is 0.8. If the government increases spending by $10 billion, real GDP will increase by:

Question

Quizplus · Accepted Answer

The government collects 20% of any increase in GDP, so if real GDP increases by x, the government collects 0.2x in taxes.

If the marginal propensity to consume is 0.8, this means that for every $1 increase in income, people will spend 80 cents and save 20 cents.

If government spending increases by $10 billion, and the MPC is 0.8, then real GDP will increase by:

ΔY = ΔG * (1 / (1 - MPC))

ΔY = $10 billion * (1 / (1 - 0.8))

ΔY = $10 billion * (1 / 0.2)

ΔY = $50 billion

Therefore, the correct answer is C) $27.8 billion.

Real GDP Equals $200 Billion, the Government Collects 20% of Any