In: Economics
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 |
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5; 14 |
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7; 10 |
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2; 35 |
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.