You are hired by the Bureau of Economic Analogies (BEA) as an economic consultant. The Chairperson of the BEA tells you that he believes the current unemployment rate is too low. The unemployment rate can be increased if aggregate output decreases. He wants to know what policy to pursue to decrease aggregate output by $100 billion. The best estimate he has for the MPC is 0.9. Which of the following policies should you recommend?

Question

Quizplus · Accepted Answer

To decrease aggregate output by $100 billion with an MPC (marginal propensity to consume) of 0.9, the government should decrease its spending by an amount smaller than $100 billion due to the multiplier effect. The multiplier is calculated as 1/(1-MPC) = 1/(1-0.9) = 10. Therefore, a $10 billion decrease in government spending would lead to a $100 billion decrease in aggregate output (10 * $10 billion = $100 billion), making option A the correct policy to recommend.

You Are Hired by the Bureau of Economic Analogies (BEA)