Assume the economy is in recession and real GDP is below full employment. The marginal propensity to consume (MPC) is 0.50, and the government follows Keynesian economics by using expansionary fiscal policy to increase aggregate demand (total spending). If an increase of $1,000 billion aggregate demand can restore full employment, the government should:
A) increase spending by $250 billion.
B) decrease spending by $500 billion.
C) increase spending by $1,000 billion.
D) increase spending by $500 billion.

Question

Quizplus · Accepted Answer

The spending multiplier is 1/(1-MPC) = 1/(1-0.5) = 2. To achieve a $1,000 billion increase in aggregate demand, the government should increase spending by $1,000 billion / 2 = $500 billion.

Assume the Economy Is in Recession and Real GDP Is