The short-run multiplier is equal to 3, real GDP equals potential GDP of $8,000, and the price level is equal to 100. Suppose that government expenditure decreases by $200. The long-run effect of the decrease in government expenditure changes real GDP by
A) a decrease of 600.
B) an increase of 600.
C) nothing; that is, in the long run real GDP equals $8,000.
D) a decrease of $200 because in the long-run, the multiplier is 1.

Question

Quizplus · Accepted Answer

In the long run, the economy adjusts to bring real GDP back to its potential level, which is $8,000 in this case. Changes in government expenditure can affect the level of real GDP in the short run due to the multiplier effect, but in the long run, the economy self-adjusts through changes in prices, wages, and interest rates to return to potential output. Therefore, the long-run effect of a decrease in government expenditure is that real GDP remains unchanged at its potential level.

The Short-Run Multiplier Is Equal to 3, Real GDP Equals