The economy is in long-run equilibrium.Aggregate demand then shifts left $50 billion.The government wants to change its spending in order to avoid a recession.If the crowding-out effect is always half as strong as the multiplier effect,and if the MPC equals 0.9,by how much does government purchases have to change?
A)increase $10 billion
B)increase $50 billion
C)increase $100 billion
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The crowding-out effect is half as strong as the multiplier effect, so the government must increase spending by twice the amount of the shift in aggregate demand to avoid a recession. The MPC is 0.9, so the multiplier effect is 1/(1-MPC) = 1/(1-0.9) = 10. Therefore, the government must increase spending by 2 * $50 billion = $100 billion.

The Economy Is in Long-Run Equilibrium