A $100 million increase in government spending increases equilibrium GDP by:
A) $100 million.
B) more than $100 million.
C) less than $100 million.
D) $0.

Question

Quizplus · Accepted Answer

According to the Keynesian multiplier effect, an increase in government spending leads to an increase in aggregate demand, which leads to an increase in equilibrium GDP. The size of the multiplier depends on the economy's marginal propensity to consume (MPC), which measures the increase in consumer spending due to an increase in income. Assuming an MPC of 0.8, the multiplier can be calculated as 1/(1-MPC) = 1/(1-0.8) = 5. This means that a $100 million increase in government spending will lead to a $500 million increase in equilibrium GDP (5 x $100 million). Therefore, the answer is B, more than $100 million.

A $100 Million Increase in Government Spending Increases Equilibrium GDP