You are hired by the Council of Economic Advisors (CEA) as an economic consultant. The Chairperson of the CEA tells you that she believes the current unemployment rate is too high. The unemployment rate can be reduced if aggregate output increases. She wants to know what policy to pursue to increase aggregate output by $300 billion. The best estimate she has for the MPC is 0.8. Which of the following policies should you recommend?

Question

Quizplus · Accepted Answer

To increase aggregate output by $300 billion with an MPC (marginal propensity to consume) of 0.8, the government needs to increase spending by an amount that, when multiplied by the spending multiplier, equals $300 billion. The spending multiplier is 1/(1-MPC) = 1/(1-0.8) = 5. Therefore, an increase in government purchases by $60 billion, multiplied by the multiplier of 5, would increase aggregate output by $300 billion ($60 billion * 5 = $300 billion).

You Are Hired by the Council of Economic Advisors (CEA)