Question

1. What is the eventual effect on real GDP if the government increases its purchases of goods and services by $60,000?

2. What is the eventual effect on real GDP if the government, instead of changing its spending, increases transfers by $60,000? Assume the MPC has not changed.
3. An increase in government transfers or taxes, as opposed to an increase in government purchases of goods and services, will result in:___.
a. a smaller eventual effect on real GDP.
b. no change to real GDP.
c. a larger eventual effect on real GDP.
d. an identical eventual effect on real GDP.

Answer 1

Missing word in 1. "Assume the marginal propensity to consume (MPC) is 0.75."

1. Using the ffg formula to calculate the effect of real GDP

Real GDP = [1/1-MPC]*Government purchase

= [1 / 1 - 0.75]*60,000

= (1/0.25)*60,000

= 4*60,000

= $240,000

Thus, the total change in real GDP is $240,000, it means the real GDP increases by $240,000

2. Real GDP = (MPC/1-MPC)*Government spending

= 0.75/1-0.75*60,000

= 0.75/0.25 * 60,000

= $180,000

Thus, the total change in real GDP is $180,000, it means the real GDP increases by $180,000

3. Thus, from the calculation, it is clear than an increase in government transfers or taxes as opposed to an increase in government purchases of goods and services will result in a smaller eventually effect on real GDP.