Exhibit 15-2 Aggregate demand and supply model Suppose the economy in Exhibit 15-2 is in equilibrium at point E₁ and the marginal propensity to consume (MPC) is 0.75. Following Keynesian economics, the federal government can move the economy to full employment at point E₂ by: A) decreasing government spending by $750 billion. B) decreasing government spending by $100 billion. C) increasing government spending by $25 billion. D) decreasing government spending by $25 billion. E) None of the above.

Question

Quizplus · Accepted Answer

Following Keynesian economics, the government can move the economy to full employment by increasing government spending. The MPC is 0.75, which means that for every $1 increase in government spending, aggregate demand will increase by $4 (1/1-0.75). Therefore, to close the recessionary gap of $100 billion (difference between Real GDP at point E₁ and potential Real GDP at point E₂), the government needs to increase spending by $25 billion (100/4). So, choice C is the best option.

Exhibit 15-2 Aggregate Demand and Supply Model Suppose the Economy