Assuming the MPC is .75, an equal $10 billion increases in government spending and tax collections will:
A)leave the equilibrium GDP unchanged.
B)increase the equilibrium GDP by $10 billion.
C)increase the equilibrium GDP by $2.5 billion.
D)reduce the equilibrium GDP by $10 billion.

Question

Quizplus · Accepted Answer

According to the multiplier effect formula, the change in equilibrium GDP equals the initial change in spending times the multiplier, and the multiplier equals 1/(1-MPC). So, in this case, the multiplier would be 1/(1-0.75) = 4.

Therefore, the equal $10 billion increase in government spending and tax collections would result in a total change in spending of $10 billion x 2 = $20 billion (assuming the tax collections are used to fund the increase in government spending).

The change in equilibrium GDP would be $20 billion x 4 = $80 billion. So the equilibrium GDP would increase by $80 billion.

Assuming the MPC Is