Use the aggregate expenditures model and assume an economy is in equilibrium at $5 trillion which is $250 billion below full-employment GDP. If the marginal propensity to consume (MPC)is 0.60, full-employment GDP can be reached if government spending:
A)increases by $60 billion.
B)increases by $100 billion.
C)increases by $250 billion.
D)is held constant.

Question

Quizplus · Accepted Answer

To close the $250 billion gap to full-employment GDP, government spending needs to increase by $100 billion. The spending multiplier is 1/(1-MPC) = 1/0.4 = 2.5. Therefore, an increase of $100 billion in government spending will result in a $250 billion increase in GDP (100 billion * 2.5 = 250 billion).

Use the Aggregate Expenditures Model and Assume an Economy Is