Suppose that the federal government allocates $100 million to clean up after a record snowfall bury the Maritimes.It also raises taxes by $100 million to keep the deficit from growing.If the marginal propensity to consume is 0.9, what is the effect on equilibrium GDP?

Question

Quizplus · Accepted Answer

Since the government spending is $100 million, and the marginal propensity to consume is 0.9, this means that the increase in government spending will lead to an increase in consumption expenditure by $90 million (0.9 x $100 million). This increase in consumption expenditure will lead to a further increase in GDP by $90 million, which when added to the initial injection of $100 million, will result in a total increase in GDP of $190 million. Therefore, the correct answer is D, GDP increases by $100 million.

Suppose That the Federal Government Allocates $100 Million to Clean