Question

The economy is in a recession. The government enacts a policy to increase spending by $2 billion. The MPS is 0.2. What would be the full increase in real GDP from the change in government spending, assuming that the aggregate supply curve is horizontal across the range of GDP being considered?

Answer 1

Answer:

The real GDP will increase by $10 billion.

Explanation:

The MPS is given as 0.2.

The increase in government spending is $2 billion.

The horizontal supply curve means that the price level is constant.

The increase in real GDP will be

= $change\ in\ government\ spending\ \times\ government\ spending\ multiplier$

= $2\ billion\ \times\frac{1}{MPS}$

= $2\ billion\ \times\frac{1}{0.2}$

= $2\ billion\ \times\ 5$

= $10 billion