Question

As an elected official, you have been informed that real GDP is below its potential and that action should be taken to encourage economic growth and bring the economy to its long-run equilibrium. If the marginal propensity to consume is 0.8 and the amount of new government spending is $600 billion, by how much would the economy be stimulated? A. $3,000 billion B. –$3,000 billion C. $600 billion D. –$600 billion E. $480 billion

Answer 1

Answer:

The correct answer is option A.

Explanation:

An economy is operating below its potential level.  

The marginal propensity to consume is 0.8.

The amount of new government spending is $600 billion.  

The change in the GDP will depend on the size of the spending multiplier.  

ΔGDP  

= $\frac{1}{1-MPC}\ \times\ \Delta G$

= $\frac{1}{1-0.8}\ \times\ 600$

= $\frac{1}{0.2}\times\ 600$

= $3,000 billion