Question

Suppose that the MPC is 0.8 and that $14 trillion of real GDP is currently being demanded. The government wants to increase real GDP demanded to $15 trillion at the given price level. By how much would it have to increase government purchases to achieve this goal?

Answer 1

Answer:

$200 billion

Explanation:

Given that,

Marginal propensity to consume, MPC = 0.8

Real GDP currently being demanded = $14 trillion

Government wants to increase real GDP demanded to $15 trillion.

Multiplier:

$=\frac{1}{1 - MPC}$

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

= 5

Government wants to increase real GDP by:

= $15 trillion - $14 trillion

= $1 trillion

Therefore, the government has to increase spending:

$=\frac{1}{multiplier}\times Desired\ increase\ in\ real\ GDP$

$=\frac{1}{5}\times 1 trillion$

= 0.2 × $1 trillion

= $200 billion