Question

Suppose the economy is operating at an output of $4,000 billion. Assume furthermore that potential output is $5,000 billion and the marginal propensity to consume is 0.75. _____ would close this recessionary gap.

Answer 1

Answer:

The correct answer is $250 billion.

Explanation:

An economy is operating at an output level of $4,000 billion.  

The potential output level is $5,000 billion.  

The marginal propensity to consume is 0.75.  

The recessionary gap is

= $5,000 billion - $4,000 billion

= $1,000 billion

ΔY = $\frac{1}{1-MPC}\times \Delta G$

$1,000 = $\frac{1}{1-0.75}\times \Delta G$

$1,000 = $\frac{1}{0.25}\times \Delta G$

$1,000 = $4 \times \Delta G$

ΔG = $\frac{1,000}{4}$

The change in income required to correct this recessionary gap is $250 billion.