Question

Currently, a​ government's budget is balanced. The marginal propensity to consume is 0.80. The government has determined that each additional ​$10 billion in new government debt it issues to finance a budget deficit pushes up the market interest rate by 0.20 percentage points. It has also been determined that every 0.10 ​(​one-tenth​) ​percentage-point change in the market interest rate generates a change in planned investment expenditures equal to ​$4 billion.​ Finally, the government knows that to close a recessionary gap and take into account the resulting change in the price​ level, it must generate a net rightward shift in the aggregate demand curve equal to ​$200 billion.
Assuming that there are no direct expenditure offsets to fiscal​ policy, calculate the increase in government expenditures necessary to close the recessionary gap. ​ (Hint: How much private investment spending will each​ $10 billion increase in government spending crowd​ out?) ​

$ ___ billion. ​(Enter your response rounded to two decimal​ places.)

Answer 1

The amount of ​$25.00 billion will be the private investment spending that each​ $10 billion increase in government spending will crowd​ out.

What is the explanation on government expenditure?

When the government expenditure increased by​ $1 billion, the planned investment expenditure will falls by ​​$0.20 billion., hence, for each​ $1 billion increase in government​ spending, there is a net change in intial spending​ of $0.2 billion

Also, the aggregate demand curve will shift to the right by the net change in spending multiplied by the​ multiplier, which equals 1- MPC.

Hence, the net increase in AD due to the​ $1 billion increase in government expenditure is equals what is known as the net multiplier.

Therefore, the amount of ​$25.00 billion will be the private investment spending that each​ $10 billion increase in government spending will crowd​ out.

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