In the Keynesian-cross model, if government purchases increase by 250, then the equilibrium level of income:
A) increases by 250.
B) increases by more than 250.
C) decreases by 250.
D) increases, but by less than 250.

Question

Quizplus · Accepted Answer

In the Keynesian-cross model, an increase in government purchases will increase aggregate demand, shifting the expenditure line upward. This will lead to an increase in equilibrium income. The magnitude of the increase in equilibrium income will depend on the size of the multiplier. Assuming a marginal propensity to consume of 0.8, the multiplier would be 5 (1/(1-0.8)). Therefore, an increase in government purchases of 250 would lead to an increase in equilibrium income of 1,250 (250 x 5). Thus, the correct answer is B, as the equilibrium level of income increases by more than 250.

In the Keynesian-Cross Model, If Government Purchases Increase by 250