The equilibrium level of real GDP is $1,000, the target level of real GDP is $1,250, and the marginal propensity to consume (MPC) is 0.60. The target can be reached if government spending is:
A) increased by $60 billion.
B) increased by $100 billion.
C) increased by $250 billion.
D) held constant.

Question

Quizplus · Accepted Answer

To calculate the required increase in government spending to reach the target level of real GDP, we can use the formula:

ΔG = (ΔY / MPC) - ΔY

where ΔG is the required increase in government spending, ΔY is the difference between the target level and equilibrium level of real GDP, and MPC is the marginal propensity to consume.

Plugging in the given values, we get:

ΔG = (1250 - 1000) / 0.60 - (1250 - 1000)
ΔG = 250 / 0.60 - 250
ΔG = 416.67 - 250
ΔG = 166.67

Therefore, the required increase in government spending to reach the target level of real GDP is $166.67 billion, which is closest to answer choice B of increasing government spending by $100 billion.

The Equilibrium Level of Real GDP Is $1,000, the Target