Question

Real GDP Planned Government Net Aggregate Consumption Investment Purchases Exports Expenditures $2,000 $1,600 $250 $250 $100 2,500 2,000 250 250 100 3,000 2,400 250 250 100 3,500 2,800 250 250 100 If potential GDP is $4,000 billion, how much should government spending increase so that the economy can move to the full employment level of GDP? (Hint: multiplier effect) $100 O $300 $200 $400 O C DOLL

Answer 1

Answer ) Option - A

We first calculate the MPC (marginal propensity to consume) of the individual and then calculate the spending multiplier.

MPC = (change in consumption)/(change in income)

As, we can see that as the income/GDP increases from $2,000 to $2,500, the consumption increases from $1,600 to $2,000.

So,

Change in income = $500

Change in Consumption = $400

MPC = (400/500) = 0.8

Now, we calculate the multiplier as follows:

Multiplier = 1/(1 - MPC)

= 1/(1 - 0.8)

= 1/0.2

Multiplier = 5

As it is given that the current level of GDP is equal to $3500 and the potential GDP is equal to $4000.

So, the output gap is equal to $500 (4000 - 3500)

Increase in GDP = Multiplier * Increase in government spending

500 = (5) x (increase in government spending)

Increase in government spending = 500/5 = $100