If the MPC is 0.5, and the government cuts spending by $400 billion, the overall effect on GDP will be:
A) a decrease of $400 billion.
B) an increase of $400 billion.
C) a decrease of $800 billion.
D) an increase of $800 billion.

Question

Quizplus · Accepted Answer

The MPC (marginal propensity to consume) of 0.5 indicates that for every dollar decrease in government spending, there will be a 50 cent decrease in consumption spending. Therefore, the total decrease in aggregate demand (GDP) will be the initial $400 billion government spending cut plus the secondary decrease in consumer spending of $400 billion (0.5 x $400 billion). This results in a total decrease in GDP of $800 billion.

If the MPC Is 0