Suppose the economy is operating at its full-employment-noninflationary GDP and the MPC is .75.The federal government now finds that it must increase spending on military goods by $21 billion in response to deterioration in the international political situation.To sustain full-employment-noninflationary GDP,government must:
A) reduce taxes by $28 billion.
B) reduce transfer payments by $21 billion.
C) increase taxes by $21 billion.
D) increase taxes by $28 billion.

Question

Quizplus · Accepted Answer

To offset the $21 billion increase in government spending and maintain full-employment-noninflationary GDP, taxes must be increased by $28 billion. With an MPC of 0.75, the multiplier is 4, so a $21 billion increase in spending would increase GDP by $84 billion. To counteract this, taxes must be increased by $28 billion, which would decrease GDP by $84 billion (since the tax multiplier is -3).

Suppose the Economy Is Operating at Its Full-Employment-Noninflationary GDP and the MPC