Assume the marginal propensity to consume (MPC) is 0.75 and the economy is in recession with real GDP $1 trillion below full-employment real GDP. To achieve full employment, aggregate demand (AD) must be increased $2 trillion. Following discretionary fiscal policy, government spending should be increased:
A) $0.25 trillion.
B) $1 trillion.
C) $0.5 trillion.
D) $2 trillion.

Question

Quizplus · Accepted Answer

The spending multiplier is 1/(1-MPC) = 1/(1-0.75) = 4. To increase AD by $2 trillion, government spending should be increased by $2 trillion / 4 = $0.5 trillion.

Assume the Marginal Propensity to Consume (MPC) Is 0