Use the aggregate expenditures model and assume an economy is in equilibrium at $6 trillion which is $500 billion below full-employment GDP. If the marginal propensity to consume (MPC)is 0.75, full-employment GDP can be reached if government spending:
A)increases by $75 billion.
B)increases by $125 billion.
C)increases by $500 billion.
D)is held constant.

Question

Quizplus · Accepted Answer

To close a $500 billion gap with an MPC of 0.75, the government spending multiplier is 1/(1-MPC) = 4. Therefore, an increase in government spending of $125 billion will increase GDP by $125 billion * 4 = $500 billion, reaching full-employment GDP.

Use the Aggregate Expenditures Model and Assume an Economy Is