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)decreases by $60 billion.
B)decreases by $100 billion.
C)decreases by $250 billion.
D)is held constant.

Question

Quizplus · Accepted Answer

To close the $250 billion gap to full-employment GDP, government spending should increase, not decrease. However, the question asks for a decrease, which is incorrect. The correct action would be to increase government spending by $100 billion, as the spending multiplier is 1/(1-MPC) = 2.5, and $100 billion * 2.5 = $250 billion.

Use the Aggregate Expenditures Model and Assume an Economy Is