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 high. The unemployment rate can be reduced if aggregate output increases. He wants to know what policy to pursue to increase aggregate output by $200 billion. The best estimate he has for the MPC is 0.6. Which of the following policies should you recommend?

Question

Quizplus · Accepted Answer

The multiplier effect of government spending is the reciprocal of the marginal propensity to consume (MPC). In this case, the MPC is 0.6, so the multiplier is 1/0.6 = 1.67. Therefore, a $80 billion increase in government spending would lead to an increase in aggregate output of $80 billion multiplied by 1.67, or $133.33 billion. This is more than the required increase of $200 billion, so it is the recommended policy choice. Option B would reduce aggregate output, while option C would have only a small positive effect. Option D would not have any immediate effect on aggregate output.

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