Suppose that Congress allocates $5 billion to an "energy-efficient appliance rebate" program.It also raises taxes by $5 billion to keep the deficit from growing.If the marginal propensity to consume is 0.8,what is the effect on equilibrium GDP?
A)GDP does not change.
B)GDP increases by $25 billion.
C)GDP increases by $4 billion.
D)GDP increases by $5 billion.

Question

Quizplus · Accepted Answer

The $5 billion energy-efficient appliance rebate program will increase aggregate demand, leading to an increase in GDP. The multiplier effect will also amplify the increase in GDP. The marginal propensity to consume (MPC) of 0.8 means that for every $1 increase in disposable income, consumers will spend $0.80. Therefore, the $5 billion rebate program will create $4 billion in additional consumption spending (0.8 x $5 billion = $4 billion). Applying the multiplier effect, the increase in GDP will be 1/ (1-0.8) x $4 billion = $20 billion. However, the increase in taxes of $5 billion will offset part of this increase. Therefore, the net effect on equilibrium GDP will be an increase of $5 billion ($20 billion - $5 billion = $15 billion).

Suppose That Congress Allocates $5 Billion to an "Energy-Efficient Appliance