Suppose that real GDP is initially $100 trillion and the government attempts to increase real GDP to $101 trillion. The marginal propensity to consume is 0.75, and every $1.00 increase in real government spending crowds out $0.50 in real planned investment expenditures. How much increase in real government spending could lead to the desired level of real GDP?

Question

Quizplus · Accepted Answer

First, we need to find out the multiplier effect of an increase in government spending.

Multiplier = 1 / (1 - MPC)

where MPC is the marginal propensity to consume.

Multiplier = 1 / (1 - 0.75) = 4

This means that for every $1 increase in government spending, real GDP will increase by $4.

Next, we need to find out how much real planned investment expenditures will be crowded out by the increase in government spending.

Crowding out effect = MPC * (change in government spending)

Crowding out effect = 0.75 * ($1)

Crowding out effect = $0.75

This means that for every $1 increase in government spending, $0.75 of planned investment expenditures will be crowded out.

To increase real GDP from $100 trillion to $101 trillion, an increase in real GDP of $1 trillion is required.

Using the multiplier effect, we can calculate the required increase in government spending:

$1 trillion / 4 = $250 billion

However, the actual increase in government spending needs to be higher than this due to the crowding out effect.

Increase in government spending = $250 billion / (1 - $0.50)

Increase in government spending = $500 billion

Therefore, the correct answer is C) $500 billion.

Suppose That Real GDP Is Initially $100 Trillion and the Government