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 $800 billion. The best estimate she has for the MPC is 0.8. Which of the following policies should you recommend?

Question

Quizplus · Accepted Answer

With an MPC of 0.8, the spending multiplier is 1/(1-MPC) = 5. Increasing government spending by $800 billion will increase aggregate output by $800 billion * 5 = $4000 billion. However, increasing taxes by $800 billion will decrease aggregate output by $800 billion * 0.8 * 5 = $3200 billion. The net effect is an increase in aggregate output by $800 billion ($4000 billion - $3200 billion).

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