Suppose the MPC equals 0.6 and government purchases increase by $2 trillion.How will equilibrium real GDP demanded change?
A) It will increase by $5 trillion.
B) It will increase by $2 trillion
C) It will decrease by $5 trillion.
D) It will decrease by $2 trillion.

Question

Suppose the MPC equals 0.6 and government purchases increase by $2 trillion.How will equilibrium real GDP demanded change?  
A) It will increase by $5 trillion. 
B) It will increase by $2 trillion 
C) It will decrease by $5 trillion. 
D) It will decrease by $2 trillion.

Quizplus · Accepted Answer

The increase in equilibrium real GDP demanded is calculated using the multiplier effect, which is 1/(1-MPC). With an MPC of 0.6, the multiplier is 1/(1-0.6) = 2.5. Therefore, a $2 trillion increase in government purchases results in a $5 trillion increase in equilibrium real GDP demanded (2 trillion * 2.5 = 5 trillion).

Suppose the MPC Equals 0