A government announces that it will increase government purchases by $20 billion. If the MPC = .8, what impact will this have on the equilibrium level of real GDP after the full potential expenditure multiplier effect is felt?
A) It will decrease by $80 billion.
B) It will increase by $100 billion.
C) It will increase by $25 billion.
D) It will decrease by $25 billion.

Question

Quizplus · Accepted Answer

The multiplier effect formula is 1/(1-MPC), so with an MPC of .8, the multiplier is 1/(1-.8) = 5. Therefore, a $20 billion increase in government purchases would increase the equilibrium level of real GDP by 5 * $20 billion = $100 billion.

A Government Announces That It Will Increase Government Purchases by $20