In the simple Keynesian model with no government and foreign sectors,assume that full employment occurs at an output of $10,000.With a marginal propensity to consume of 0.5 and equilibrium output at $9,600,by how much will investment spending have to increase to move the economy to full employment?
A) $100
B) $400
C) $200
D) $50

Question

Quizplus · Accepted Answer

The output gap is the difference between equilibrium output and full employment output, which is $10,000 - $9,600 = $400. To close the output gap, we need an increase in aggregate demand, which is the sum of consumption and investment spending. Since the marginal propensity to consume is 0.5, we know that for every $1 increase in real disposable income, consumption spending will increase by $0.5. Therefore, to increase aggregate demand by $400, we need investment spending to increase by $400 / (1 - 0.5) = $800. However, we only need to increase investment spending by enough to close the output gap, which is $400. Therefore, the required increase in investment spending is $400 / 2 = $200.

In the Simple Keynesian Model with No Government and Foreign