In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion increase in government spending increases planned expenditures by and increases the equilibrium level of income by .
A)$1 billion; more than $1 billion
B)$.75 billion; more than $.75 billion
C)$.75 billion; $.75 billion
D)$1 billion; $1 billion

Question

Quizplus · Accepted Answer

According to the Keynesian-cross model, the change in equilibrium level of income is calculated as the multiplier effect of the change in autonomous expenditure (in this case, government spending). The multiplier = 1/(1-MPC) = 1/(1-0.75) = 4. Therefore, a $1 billion increase in government spending will increase planned expenditures by $1 billion x MPC = $0.75 billion. The increase in equilibrium income will be the multiplier effect of this increase in planned expenditures, which is $0.75 billion x multiplier = $0.75 billion x 4 = $3 billion. Therefore, the correct answer is A, a $1 billion increase in government spending increases planned expenditures by $0.75 billion and increases the equilibrium level of income by more than $1 billion.

In the Keynesian-Cross Model, If the MPC Equals 0