Question

If the economy experiences a recession with a current spending gap $1,000 below full-employment output, and the marginal propensity to consume is 0.8, how much must government increase spending to restore the economy to full-employment GDP?

Answer 1

Answer:

Change in Investment  (Government Spending) = $200

Explanation:

Multiplier = k =∆Y/∆I = 1/(1-MPC)

Needed ∆Y = $1000  ;  MPC = 0.8

1000/ ∆I = 1 / (1-0.8)

1000/∆I  = 1 / 0.2

1000/∆I  = 5

∆I  = 1000/5

∆I = 200