Question

Assume that in the year 2025 the US economy is in a recession that would require a $1 Trillion increase in total spending to get back to full employment output. Answer the following questions assuming that the marginal propensity to consume is 0.8.

Identify the least amount the government could spend to get the economy back to full employment. Show your work

Answer 1

Using the multiplier effect with a marginal propensity to consume of 0.8, the least amount the government could spend to get the US economy back to full employment in 2025 is $200 Billion.

Step-by-step explanation:

To determine the least amount the government could spend to get the economy back to full employment, we need to understand the concept of the multiplier effect in the Keynesian economic model. The multiplier effect occurs because an initial increase in spending leads to further income and spending throughout the economy. The marginal propensity to consume (MPC) is given as 0.8, which means the multiplier (M) can be calculated using the formula M = 1 / (1 - MPC).

Following the formula, we get:

• M = 1 / (1 - 0.8)
• M = 1 / 0.2
• M = 5

With a multiplier of 5, the government spending required to achieve the full employment output can be found by dividing the total spending needed by the multiplier.

Answer 2

The least government spending required to reach full employment in the US economy, with a marginal propensity to consume of 0.8, is $200 Billion, due to the multiplier effect which is calculated as 1/(1-0.8).

Step-by-step explanation:

To calculate the least amount of government spending required to get the US economy back to full employment with a marginal propensity to consume of 0.8, we must first understand the concept of the spending multiplier effect. This effect describes how an initial increase in spending leads to further rounds of spending by households and businesses, thus having a greater impact on the economy than the initial amount spent.

The formula for the spending multiplier is 1/(1-MPC), where MPC is the marginal propensity to consume. Substituting the given MPC of 0.8 into the formula gives us a multiplier of 1/(1-0.8) = 5. Therefore, to achieve a $1 Trillion increase in total spending, the government only needs to spend 1/5 of this amount, due to the multiplier effect.

The calculation is: $1 Trillion / 5 = $200 Billion. So, the government would need to spend at least $200 Billion to boost the economy back to full employment, thanks to the Keynesian multiplier.