Question

Suppose the price level is fixed, the MPC is 0.5, and the GDP gap is a negative $80 billion. To achieve full-employment output (exactly), government should

Answer 1

Answer:

The government should increase spending by $40 million.

Explanation:

The MPC is given as 0.5.

The recessionary gap is $80 billion, this means to reach full employment level of output, the government needs to increase income by $80 billion.

Increase in GDP = $Change\ in\ government\ spending\ \times\ spending\ multiplier$

Increase in GDP = ΔG\ \times\ $\frac{1}{1-MPC}$

$80 billion = Δ$G\ \times\ \frac{1}{1-0.5}$

$80 billion = Δ$\frac{G}{0.5}$

ΔG = $80 billion\ \times\ 0.5$

ΔG = $40 billion