In an economy, the government wants to increase aggregate demand by $50 billion at each price level to increase real GDP and reduce unemployment. If the MPS is 0.4, then it could increase government
Spending by
A) $10 billion.
B) $20 billion.
C) $31.25 billion.
D) $40.50 billion.

Question

Quizplus · Accepted Answer

To increase aggregate demand by $50 billion, we need to increase government spending by a multiple of the reciprocal of the MPS. 
Reciprocal of MPS = 1/0.4 = 2.5 
Increase in government spending = 2.5 x $50 billion = $125 billion 
Therefore, the government can increase government spending by $20 billion (closest option) to achieve the desired increase in aggregate demand.

In an Economy, the Government Wants to Increase Aggregate Demand