Question

If the marginal propensity to consume (mpc) is 0.75, a $50 decrease in government spending, other things being equal, would cause equilibrium real gdp to:

Answer 1

Answer: We use the multiplier formula here,

$Multiplier = \frac{1}{1-mpc} = \frac{1}{1-0.75} = \frac{1}{0.25} = 4$

Now, as multiplier is equal to

$Multiplier = \frac{Change in GDP}{Change in G} 4 = \frac{Change in GDP}{-50} Change in GDP = 4*(-50) Change in GDP = - 200$

Therefore, equilibrium GDP falls by $200.