Calculate the change in government purchases of goods and services necessary to close the gap. Refer...

Calculate the change in government purchases of goods and services necessary to close the gap. Refer to the following example to fill the blanks in the questions.

Real GDP equals $100 billion, potential output equals $170 billion, and the marginal propensity to consume is 0.8.

Since the multiplier for a change in government purchases of goods and services is _______, an increase in government purchases of $_______ billion will increase real GDP by $70 billion and close the recessionary gap.

		4; 15
		5; 14
		7; 10
		2; 35

Solutions

Expert Solution

Solution:

Recessionary gap = potential output - real gross domestic product (GDP)

Recessionary gap = 170 - 100 = $70 billion

Multiplier = 1/(1 - marginal propensity to consume) = 1/(1 - 0.8) = 5

Increase in real GDP/output = multiplier*increase in government purchases

70 billion = 5*increase in government purchases

So, increase in government purchases = 70 billion/5 = $14 billion

Thus, the correct option is (B) 5 ; 14.

Rahul Sunny answered 2 years ago

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