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. if the marginal propensity to consume is 0.8 and the amount of new government spending is $600 billion, by how much would the economy be stimulated

Answer 1

To find the answer, we first calculate the multiplier.

By using the equation,

ms= 1 ÷ (1 – MPC)

MPC = marginal propensity to consume = 0.8

ms= 1 ÷ (1 – MPC) = 1 ÷ (1 - 0.8)

= 5

Thus, the multiplier is 5.

An increase in government spending = $600 billion

Now, multiplied $600 billion by the multiplier, which is 5.

$600 billion x 5

= $3,000

Thus, the answer is $3,000 billion increase in real GDP.