Econia's real GDP is $700 billion. Full-employment real GDP is $900 billion. The MPC = .75. If the full multiplier effect occurs, which of the following policies would move the economy to a full-employment equilibrium?
A) Decrease government purchases by $150 billion.
B) Decrease taxes by $150 billion.
C) Increase government purchases by $50 billion.
D) Increase taxes by $50 billion.

Question

Quizplus · Accepted Answer

To move the economy to full-employment equilibrium, the government needs to increase aggregate demand. The multiplier formula is 1/(1-MPC), which in this case is 1/(1-0.75) = 4. To close a $200 billion gap (from $700 billion to $900 billion), the government needs to increase spending by $50 billion, because $50 billion * 4 (multiplier) = $200 billion. Options A, B, and D would not achieve this goal.

Econia's Real GDP Is $700 Billion