By how much would the government spending need to increase to prevent the $300mil decrease in output?

Imagine that the US economy suddenly falls into the recession and the GDP is forecasted to decrease by $300mil. We know that the propensity to consume (c₁) is 0.6. The government wants to fight the recession and it is considering either a massive spending boost or a new tax reform

Question: By how much would the government spending need to increase to prevent the $300mil decrease in output?

(Report your answer in millions. For example, if your answer is $550mil, write down "550".)

Solutions

Expert Solution

Ans. The required increase in GDP = $300 million

Government spending multiplier = 1/(1-MPC) = 1/(1-06) = 2.5

The required increase in GDP = Government Spending Multiplier * Change in Government Spending

=> 300 million = 2.5*Change in Government Spending

=> Change in Government Spending = $120 million

Thus, the government spending should increase by $120 million to prevent $300 million decrease in output.

Rahul Sunny answered 1 year ago

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