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

Question

Quizplus · Accepted Answer

The spending multiplier is 1/(1-MPC) = 1/0.25 = 4. To reduce GDP by $500 billion, government spending should decrease by $500 billion / 4 = $125 billion.

Use the Aggregate Expenditures Model and Assume an Economy Is