Assume the economy is in recession and real GDP is below full employment. The marginal propensity to consume (MPC) is 0.75 and the government follows Keynesian economics by using expansionary fiscal policy to increase aggregate demand (total spending). If an increase of $1000 billion aggregate demand can restore full employment, the government should:
A) decrease spending by $750 billion.
B) increase spending by $750 billion.
C) increase spending by $1000 billion.
D) increase spending by $250 billion.

Question

Quizplus · Accepted Answer

Given the MPC of 0.75, the multiplier effect is 1/(1-MPC) = 1/(1-0.75) = 4. To increase aggregate demand by $1000 billion, the government should increase spending by $1000 billion / 4 = $250 billion.

Assume the Economy Is in Recession and Real GDP Is