Question

Assume the economy is in recession and real GDP is below full employment. Themarginal propensity to consume (MPC) is 0.90, and the government follows Keynesianeconomics by using expansionary fiscal policy to increase aggregate demand (totalspending). If an increase of $1,000 billion aggregate demand can restore full employment,the government should:

a.increase spending by $100 billion.
b. decrease spending by $790 billion.
c.increase spending by $1,000 billion.
d. increase spending by $250 billion.

Answer 1

a.increase spending by $100 billion.

Step-by-step explanation:

For computing the effect, first we have to find out the multiplier then, the spending amount effect which is shown below:

Government spending multiplier = 1 ÷ (1 - marginal propensity to consume)

Government spending multiplier = 1 ÷ (1 - 0.90)

Government spending multiplier = 1 ÷ 0.10

So, Government spending multiplier = 10

Now the effect of spending would be

= Output level at full employment ÷ Government spending multiplier

= $1,000 billion ÷ 10

= $100 billion increase