If the marginal propensity to consume is 0.8, full-employment output is $14 trillion, and current output is $13.5 trillion, then investment spending must _____ to reach full-employment output.
A) decrease by $0.5 trillion
B) increase by $0.1 trillion
C) increase by $0.4 trillion
D) increase by $0.5 trillion

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is 0.8, meaning for every additional dollar earned, 80 cents is spent on consumption. The output gap is $0.5 trillion ($14 trillion - $13.5 trillion). To close this gap with an MPC of 0.8, the multiplier is 1/(1-MPC) = 1/(1-0.8) = 5. Therefore, an increase in investment spending of $0.1 trillion, multiplied by the multiplier of 5, would increase total output by $0.5 trillion, closing the gap and reaching full-employment output.

If the Marginal Propensity to Consume Is 0