During a recession, analysts at the CBO project that the economy is operating $750 billion below potential output. Assuming the MPC is 0.6, by how much would the government have to increase spending to restore potential output?
A) $333 billion
B) $300 billion
C) $250 billion
D) $750 billion

Question

Quizplus · Accepted Answer

The government would have to increase spending by the amount of the output gap divided by the MPC. So, $750 billion / 0.6 = $1,250 billion. However, the government only needs to increase spending by the portion of that amount that is not currently being spent, which is equal to the output gap itself ($750 billion). Therefore, $750 billion / 0.6 = $1,250 billion, but the government only needs to increase spending by $750 billion. Thus, the answer is B) $300 billion.

During a Recession, Analysts at the CBO Project That the Economy