Question

1. Suppose that real GDP is currently $15 trillion and the MPC is .8. How much would government have to increase spending to increase real GDP by $5 trillion?
2. If the MPC is .7 and government decreased spending by $500 billion, what is the spending multiplier and by how much would real GDP decrease?

Answer 1

ANswer
a)
Spending multiplier =1/(1-MPC)
=1/(1-0.8)
=5
the required change in government spending =required change in GDP/multiplier
=5/5
=$1 trillion
government have to increase spending by $1 trillion to increase real GDP by $5 trillion
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b)
Multiplier =1/(1-0.7)
=3.33333333
=3.33
the spending multiplier is 3.33
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change in real GDP =change in government spending *multiplier
=(-500)*3.33333333
=-1666.66666
the minus sign shows a decrease
the real GDP decreases by $1666.67 billion