Question

an adverse demand shock caused ad to decrease by $200 billion. if the economy's marginal propensity to consume (mpc) is 0.7, what is the appropriate size of the fiscal stimulus package (that is what is the increase in spending) that will completely offset that decrease and bring back ad to its original position? a. $140 billion b. $60 billion c. $285 billion d. none of the above

Answer 1

To counteract a $200 billion decrease in aggregate demand with an MPC of 0.7, the government would need to implement a fiscal stimulus package worth $60 billion to bring AD back to its original level. Therefore, the correct option is b. $60 billion.

Step-by-step explanation:

The student has asked about the appropriate size of a fiscal stimulus package to offset an adverse demand shock that decreased aggregate demand (AD) by $200 billion, given a marginal propensity to consume (MPC) of 0.7. To calculate the size of the fiscal stimulus, the spending multiplier is used, which is calculated as 1/(1-MPC). In this case, the spending multiplier would be 1/(1-0.7) = 3.33. Therefore, to offset the decrease in AD by $200 billion, the government would need to spend $200 billion divided by the spending multiplier, which would be $60 billion. Thus, the correct answer is b. $60 billion.