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If policy makers want to increase real GDP by $100 billion and the marginal propensity to consume is 0.75, they should _____ government purchases of goods and services by _____.

a. Increase; $100 billion

b. Increase; $25 billion

c. Increase; $33 billion

d. Decrease; $100 billion

User Ekenman
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Final answer:

The correct answer is b. To increase real GDP by $100 billion, policy makers need to increase government purchases of goods and services by $25 billion.

Step-by-step explanation:

The marginal propensity to consume (MPC) represents the fraction of any change in income that is consumed. In this case, the MPC is 0.75, meaning that for every increase in income, 75% of it is spent.

To increase real GDP by $100 billion, policy makers need to increase government purchases of goods and services by a certain amount. We can use the multiplier effect to determine this amount.

The multiplier effect demonstrates how an initial increase in spending can lead to a larger increase in real GDP. The multiplier is calculated as 1 / (1 - MPC).

In this case, the multiplier is 1 / (1 - 0.75) = 4. With a multiplier of 4, the increase in government spending needed to achieve a $100 billion increase in real GDP would be $100 billion / 4 = $25 billion.

User Rallrall
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