Question

If government expenditure rises by $27.5 billion and the multiplier in the economy is 2.5, then: ___________

a. real GDP falls by $55 billion, and the IS curve shifts to the left.
b. real GDP rises by $27.5 billion, and the IS curve shifts to the right.
c. real GDP rises by $68.75 billion, and the IS curve shifts to the right.
d. real GDP falls by $11 billion, but the IS curve does not shift.

Answer 1

c. real GDP rises by $68.75 billion, and the IS curve shifts to the right.

Step-by-step explanation:

An increase in the government expenditure will result in the rise of real GDP. This will result in the IS curve to shift to the right. However, in the case of multiplier effect, this occurrence causes a bigger increase in the national income due to the initial injection into the economy.

Therefore, the rise in government expenditure by $27.5 billion will cause real GDP to rise. Ultimately options A and D are eliminated as they mention fall in GDP.

Moreover, since the multiplier in the economy is 2.5, this will increase the government expenditure to $68.75 billion (27.5 billion x 2.5). Hence, option C is correct.