Exhibit 16-4 Macro AD/AS Model As shown in Exhibit 16A-4, assume the marginal propensity to consume equals 0.80. Using discretionary fiscal policy, federal government spending should be _________ in order to restore the economy from E ₁ to full employment. A) increased by $1.6 trillion B) decreased by $1.6 trillion C) increased by $.20 trillion D) decreased by $.20 trillion

Question

Quizplus · Accepted Answer

In order to restore the economy from E ₁ to full employment, the government needs to increase aggregate demand. With a marginal propensity to consume of 0.80, the multiplier is 1/1-0.8 = 5. Therefore, an increase in government spending of $320 billion ($1.6 trillion/5) would increase aggregate demand by $1.6 trillion, which should be sufficient to restore the economy to full employment.

​ Exhibit 16-4 Macro AD/AS Model

Exhibit 16-4 Macro AD/AS Model