Suppose an initial increase in government expenditure increases output by $50,000. If the size of the multiplier is 2.5, the size of the initial increase in government expenditure was _____
A) $25,000.
B) $20,000.
C) $12,500.
D) $50,000.
E) $0.

Question

Quizplus · Accepted Answer

Using the formula for the multiplier (K) which is:

K = 1 / (1 - MPC)

where MPC is the marginal propensity to consume.

If we assume that MPC is 0.6 (meaning that 60% of the additional income generated is spent), then:

2.5 = 1 / (1 - 0.6)
2.5 = 1 / 0.4

So, the initial increase in government expenditure (G) can be calculated as:

G = K x ΔY

where ΔY is the change in output, which is $50,000 in this case.

G = 2.5 x $50,000
G = $125,000

Therefore, the initial increase in government expenditure was $20,000 (Choice B).

Suppose an Initial Increase in Government Expenditure Increases Output by $50,000