Question

Suppose the Canadian government is unwilling to wait for the long-run adjustment process. The marginal propensity to consume is 0.8. The equilibrium real output is $500 billion and the full-employment output is $540 billion. (i) Calculate the minimum change and indicate the direction of change in government spending required to shift the aggregate demand curve by the amount of the output gap.

Answer 1

Given:

Marginal propensity to consume (MPC) = 0.8

Equilibrium real output = $500 billion

Full-employment output = $540 billion

Find:

Change in government spending ΔG = ?

Computation:

Change in output ΔY = Full-employment output - Equilibrium real output

Change in output ΔY = $540 billion - $500 billion

Change in output ΔY = $40 billion

Change in output ΔY = [1 / (1 - MPC)] × ΔG

$40 billion = [1 / (1 - 0.8)] × ΔG

$40 billion = [1 / (0.2)] × ΔG

$40 billion = [5] × ΔG

ΔG =  $40 billion / 5

ΔG =  $8 billion

Change in government spending ΔG = $8 billion.