If government purchases increased by $30 billion, investment spending decreased by $20 billion, and 80 percent of additional income was spent on new goods and services, total output would:
A) increase by $8.0 billion.
B) increase by $10 billion.
C) increase by $20 billion.
D) increase by $50 billion.

Question

Quizplus · Accepted Answer

The multiplier effect states that an increase in government spending will lead to a larger increase in total output. In this case, the increase in government spending is $30 billion, and the decrease in investment spending is $20 billion. So, the net increase in spending is $10 billion. Since 80% of additional income is spent on new goods and services, the total output will increase by $10 billion * 1 / (1 - 0.8) = $50 billion.

If Government Purchases Increased by $30 Billion, Investment Spending Decreased