If government purchases increase by $10 billion when the MPC is 0.8,then real GDP will increase by $50 billion.

Question

Quizplus · Accepted Answer

According to the Keynesian expenditure multiplier, a change in government spending will have a multiplied effect on real GDP. The formula for the multiplier is 1/MPC, where MPC is the marginal propensity to consume. In this case, the MPC is 0.8, so the multiplier is 1/0.8 = 1.25. Therefore, a $10 billion increase in government purchases will lead to a $10 billion x 1.25 = $12.5 billion increase in real GDP. However, the question asks for the increase in real GDP, not the total amount, so we need to subtract the initial $10 billion increase in government purchases. Therefore, the increase in real GDP is $12.5 billion - $10 billion = $2.5 billion.

If Government Purchases Increase by $10 Billion When the MPC