Assume that we want to drive our economy out of recession by generating a $400 billion change in real GDP. The MPC is 0.8. Which of the following policy prescriptions would generate the targeted $400 billion change in income?

Question

Quizplus · Accepted Answer

To achieve a $400 billion change in real GDP with an MPC of 0.8, the multiplier is 1/(1-MPC) = 1/(1-0.8) = 5. The net increase in spending (government spending minus tax revenue, considering the MPC) needs to result in a total increase of $400 billion when multiplied by 5. For option A, the net increase is $120 billion (government spending) minus $50 billion (tax revenue) times the MPC (0.8), which equals $120 billion - $40 billion = $80 billion. Multiplied by the multiplier (5), this equals $400 billion, meeting the target change in real GDP.

Assume That We Want to Drive Our Economy Out of Recession