Suppose equilibrium real GDP is currently at $800 billion and investment is $100 billion. If an increase in the interest rate reduces investment from $100 billion to $75 billion, and the MPC is 0.8, the new level of equilibrium real GDP will be:
A)$500 billion.
B)$600 billion.
C)$675 billion.
D)$775 billion.
E)$800 billion.

Question

Quizplus · Accepted Answer

The decrease in investment is $25 billion. With an MPC of 0.8, the multiplier is 1/(1-MPC) = 5. The change in GDP is 5 * (-$25 billion) = -$125 billion. Therefore, the new GDP is $800 billion - $125 billion = $675 billion.

Suppose Equilibrium Real GDP Is Currently at $800 Billion and Investment