To eliminate an AD shortfall of $100 billion when the economy has an MPC of 0.80,the government should increase transfer payments by

Question

Quizplus · Accepted Answer

The multiplier effect is 1/(1-MPC). In this case, the MPC is 0.80, so the multiplier effect is 1/(1-0.80) = 5. Therefore, to eliminate an AD shortfall of $100 billion, the government should increase transfer payments by $100 billion * 5 = $500 billion. However, the question asks for the amount by which transfer payments should be increased, not the total amount of transfer payments. Therefore, the correct answer is $500 billion - $100 billion = $400 billion.

To Eliminate an AD Shortfall of $100 Billion When the Economy