Exhibit 15-3 Aggregate demand and supply model

-Suppose the economy in Exhibit 15-3 is in equilibrium at point E₁ and the marginal propensity to consume (MPC)is 0.80.Following Keynesian economics,to restore full employment,the government should increase its spending by:

Question

Exhibit 15-3 Aggregate demand and supply model
 
-Suppose the economy in Exhibit 15-3 is in equilibrium at point E₁ and the marginal propensity to consume (MPC)is 0.80.Following Keynesian economics,to restore full employment,the government should increase its spending by:

Quizplus · Accepted Answer

To restore full employment, the government should increase its spending by an amount that, when multiplied by the spending multiplier, equals the gap in aggregate demand. The spending multiplier is 1/(1-MPC), which is 1/(1-0.80) = 5. Therefore, to achieve a $1 trillion increase in aggregate demand, the government should increase spending by $1 trillion / 5 = $200 billion.

Exhibit 15-3 Aggregate Demand and Supply Model