Narrbegin Exhibit 17.1 Aggregate demand and supply model
-Suppose the economy in Exhibit 17.1 is in equilibrium at point E₁ and the marginal propensity to consume (MPC) is 0.8. Following Keynesian economics, to restore full employment, the government should increase its spending by:

Question

Narrbegin Exhibit 17.1 Aggregate demand and supply model

-Suppose the economy in Exhibit 17.1 is in equilibrium at point E₁ and the marginal propensity to consume (MPC) is 0.8. Following Keynesian economics, to restore full employment, the government should increase its spending by:

Quizplus · Accepted Answer

Given the marginal propensity to consume (MPC) is 0.8, the multiplier effect is 1/(1-MPC) = 1/(1-0.8) = 5. To restore full employment, the government needs to increase spending by an amount that, when multiplied by the multiplier, equals the gap to full employment. If the gap is not specified, we assume a standard scenario where a $200 billion increase, multiplied by the multiplier of 5, would provide the necessary economic stimulus to restore full employment.