Suppose the economy is currently at equilibrium at $1 trillion, and the MPC is 0.6.And suppose there is a $100 billion decrease in government purchases of goods and services.Which of the following is the new equilibrium?
A) $400 billion
B) $600 billion
C) $750 billion
D) $1.4 trillion

Question

Suppose the economy is currently at equilibrium at $1 trillion, and the MPC is 0.6.And suppose there is a $100 billion decrease in government purchases of goods and services.Which of the following is the new equilibrium?  
A) $400 billion 
B) $600 billion 
C) $750 billion 
D) $1.4 trillion

Quizplus · Accepted Answer

The multiplier is calculated as 1/(1-MPC), which in this case is 1/(1-0.6) = 2.5. A $100 billion decrease in government purchases would decrease the equilibrium by 2.5 times that amount, which is $250 billion. Therefore, the new equilibrium would be $1 trillion - $250 billion = $750 billion.

Suppose the Economy Is Currently at Equilibrium at $1 Trillion