Question

As an elected official, you have been informed that real GDP is below its potential and that action should be taken to encourage economic growth and bring the economy to its long-run equilibrium. The marginal propensity to consume is 0.7, and the amount of new government spending is $600 billion.a. What is the multiplier? (Compute this to the first place beyond the decimal)b. By how much would the economy be stimulated?

Answer 1

Answer: a. Multiplier = 3.33

b. Stimulation = $2000 billion

Explanation:

In this particular case , it's given:

Marginal propensity to consume(MPC) = 0.7

Government spending = $600 billion

Therefore, we can evaluate the  multiplier using the following formula:

$Multiplier\ = \frac{1}{(1-MPC)}$

$Multiplier\ = \frac{1}{1-0.7}$

Multiplier = 3.33

Noe, in order to find the stimulation in the economy we will multiple the new government spending with the multiplier. We will get ;

$Stimulation\ = Government\ spending\times Multiplier$

$Stimulation\ = 600\times3.33$

Stimulation = $2000 billion