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Chapter 19: Problem 10

The equilibrium level of real GDP is \(\$ 1,000\) billion, the full-employment level of real GDP is \(\$ 1,250\) billion, and the marginal propensity to consume \((M P C)\) is \(0.60 .\) The fullemployment target can be reached if government spending is a. increased by \(\$ 60\) billion. b. increased by \(\$ 100\) billion. c. increased by \(\$ 250\) billion. d. held constant.

Short Answer

Expert verified
The correct increase in government spending required to reach the full-employment target is \(b. increased by \$100\ billion\), as calculated using the spending multiplier and the given equilibrium level of real GDP, full-employment level of real GDP, and the marginal propensity to consume (MPC).

Step by step solution

01

Understanding the Problem

We are given the equilibrium level of real GDP (\$1,000 billion), the full-employment level of real GDP (\$1,250 billion) and the marginal propensity to consume (MPC = 0.60). The problem asks us to find the increase in government spending that would bring the economy to its full-employment level of real GDP.
02

Calculate the Spending Multiplier

The spending multiplier is a measure of the impact a change in government spending will have on real GDP. It is calculated as follows: Spending multiplier = \(\frac{1}{1 - MPC}\) Plugging in the given MPC value: Spending multiplier = \(\frac{1}{1 - 0.60} = \frac{1}{0.40} = 2.5\)
03

Calculate the Required Increase in Government Spending

Now that we have the spending multiplier, we can calculate the required increase in government spending to reach the full-employment level of real GDP. To do this, we will use the following formula: Increase in government spending = \(\frac{Full\ employment\ level\ of\ real\ GDP - Current\ equilibrium\ level\ of\ real\ GDP}{Spending\ multiplier}\) Plugging in the given values: Increase in government spending = \(\frac{\$1,250\ billion - \$1,000\ billion}{2.5} = \frac{\$250\ billion}{2.5} = \$100\ billion\)
04

Choose the Correct Answer

Now, we will compare our answer with the given options to find the correct answer. a. increased by \$60 billion b. increased by \$100 billion c. increased by \$250 billion d. held constant Our calculated increase in government spending is \$100 billion, which matches with option b. Therefore, the correct answer is: b. increased by \$100 billion.

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Most popular questions from this chapter

If the marginal propensity to consume (MPC) is \(0.90,\) a \(\$ 100\) billion increase in planned investment expenditure, other things being equal, will cause an increase in equilibrium output of a. \(\$ 90\) billion. b. \(\$ 100\) billion. c. \(\$ 900\) billion. d. \(\$ 1,000\) billion.

The spending multiplier is defined as a. \(1 /(1-\) marginal propensity to consume). b. \(1 /\) (marginal propensity to consume). c. \(1 /(1-\) marginal propensity to save). d. \(1 /\) marginal propensity to consume \(+\) marginal propensity to save).

If the marginal propensity to consume \((M P C)\) is \(0.80,\) the value of the spending multiplier is a. 2. b. 5. c. 8. d. 10.

There will be unplanned inventory investment accumulation when a. aggregate output (real GDP) equals aggregate expenditures. b. aggregate output (real GDP) exceeds aggregate expenditures. c. aggregate expenditures exceed aggregate output (real GDP). d. firms increase output.

John Maynard Keynes proposed that the multiplier effect can correct an economic depression. Based on this theory, an increase in equilibrium output would be created by an initial a. increase in investment. b. increase in government spending. c. decrease in government spending. d. both (a) and (b). e. both (a) and (c).
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