A $0.2 trillion increase in government purchases increases the quantity demanded by $1.0 trillion, the price level remaining constant. This additional spending reflects the _____ effect.
A) recessionary
B) expansionary
C) simple spending multiplier
D) income
E) substitution

Question

Quizplus · Accepted Answer

The given scenario is an example of the simple spending multiplier effect, which states that an initial government spending increase will have a larger overall impact on the economy due to the subsequent increase in spending and consumption by individuals and businesses, resulting in a total increase in demand larger than the initial spending increase. The formula for the simple spending multiplier is 1/(1-MPC), where MPC is the marginal propensity to consume. In this scenario, the spending multiplier is 1/(1-0.8) = 5, meaning that the total increase in demand will be five times the initial increase in government purchases.

A $02 Trillion Increase in Government Purchases Increases the Quantity Demanded