Question

Suppose the economy is in a recession. The economy needs to expand by at least $300 billion, and the marginal propensity to consume is 0.6. What is the least amount the government can spend to overcome the $300 billion gap

Answer 1

Answer: $120 billion

Explanation:

Fron the question, we are told that an economy is in a recession and needs to expand by at least $300 billion, and the marginal propensity to consume is 0.6.

The least amount the government can spend to overcome the $300 billion gap goes thus:

Since MPC = 0.6, then the multiplier will be:

= 1/(1-MPC)

= 1/(1-0.6)

= 1/0.4

=2.5

We are also informed that the required change in the money supply is $300 billion. Then, the investment needed will be:

= Expansion/Multiplier

= $300 billion/2.5

= $120 billion