Exhibit 15-2 Aggregate demand and supply model

-Suppose the economy in Exhibit 15-2 is in equilibrium at point E₁ and the marginal propensity to consume (MPC)is 0.75.Following Keynesian economics,the federal government can move the economy to full employment at point E₂ by:

Question

Exhibit 15-2 Aggregate demand and supply model
 
-Suppose the economy in Exhibit 15-2 is in equilibrium at point E₁ and the marginal propensity to consume (MPC)is 0.75.Following Keynesian economics,the federal government can move the economy to full employment at point E₂ by:

Quizplus · Accepted Answer

According to Keynesian economics, to move the economy to full employment, the government needs to increase aggregate demand. One way to do this is through an increase in government spending. The formula for calculating the change in equilibrium output due to a change in government spending is:

Change in equilibrium output = (Change in government spending) x (1/MPS)

MPS is the marginal propensity to save, which is the complement of the MPC. In this case, the MPC is 0.75, so the MPS is 0.25.

To move the economy from E₁ to E₂, we need to increase output by the difference between the two equilibrium levels, which is $400 billion. Using the formula above, we get:

$400 billion = (Change in government spending) x (1/0.25)
Change in government spending = $100 billion

Therefore, the government needs to increase spending by $100 billion to move the economy to full employment at E₂. Choice C is the correct answer.

Exhibit 15-2 Aggregate Demand and Supply Model