Suppose that the economy is experiencing an expansionary gap of $1,000 and the MPC equals 0.8.With an upward-sloping short-run aggregate supply curve,the government can close the gap if it decreases purchases by
A)$1,000
B)$800
C)$200
D)more than $200
E)less than $200

Question

Quizplus · Accepted Answer

The government can close the gap by decreasing purchases by more than $200 because the multiplier effect is 1/(1-MPC) = 1/0.2 = 5. To close a $1,000 gap, the initial decrease in spending must be more than $200, as $200 * 5 = $1,000. However, due to the upward-sloping short-run aggregate supply curve, the effect is less than the full multiplier, so the decrease must be more than $200.

Suppose That the Economy Is Experiencing an Expansionary Gap of $1,000