Figure 8.8 Alt text for Figure 8.8: In figure 8.8, a graph depicting potential GDP.
Long description for Figure 8.8: The x-axis is labelled, real GDP, Y (trillions of 2002 dollars) with values GDP1 and GDP2 marked.The y-axis is labelled, real aggregate expenditure, AE (trillions of 2002 dollars) .Line AE1, begins a little less than half way on the x-axis and slopes up to the end of the x-axis.Line AE2, is to the right of AE1 and is on a similar path, sloping up to the top right corner.Line Y = AE, originates at the vertex and slopes up to the top right corner.Line Y = AE intersects line AE2 at point K, half way along both lines, and intersects line AE1 at point N, plotted close to the right end of line AE1.Point J is plotted a little less than half way along line AE2, to the left of point K.Point L is plotted close to the right end of line AE2, to the right of point K.Point K is connected to its x-coordinate, GDP1, with a dotted line.A straight line, representing potential GDP, is drawn connecting points N and L with their x-coordinate, GDP2, such that it is parallel to line connecting point K with value GDP1.
-Refer to Figure 8.8.Potential GDP equals $500 billion.The economy is currently producing GDP₁, which is equal to $450 billion.If the MPC is 0.8, then how much must autonomous spending change for the economy to move to potential GDP?

Question

Figure 8.8

Alt text for Figure 8.8: In figure 8.8, a graph depicting potential GDP.
Long description for Figure 8.8: The x-axis is labelled, real GDP, Y (trillions of 2002 dollars) with values GDP1 and GDP2 marked.The y-axis is labelled, real aggregate expenditure, AE (trillions of 2002 dollars) .Line AE1, begins a little less than half way on the x-axis and slopes up to the end of the x-axis.Line AE2, is to the right of AE1 and is on a similar path, sloping up to the top right corner.Line Y = AE, originates at the vertex and slopes up to the top right corner.Line Y = AE intersects line AE2 at point K, half way along both lines, and intersects line AE1 at point N, plotted close to the right end of line AE1.Point J is plotted a little less than half way along line AE2, to the left of point K.Point L is plotted close to the right end of line AE2, to the right of point K.Point K is connected to its x-coordinate, GDP1, with a dotted line.A straight line, representing potential GDP, is drawn connecting points N and L with their x-coordinate, GDP2, such that it is parallel to line connecting point K with value GDP1.
-Refer to Figure 8.8.Potential GDP equals $500 billion.The economy is currently producing GDP₁, which is equal to $450 billion.If the MPC is 0.8, then how much must autonomous spending change for the economy to move to potential GDP?

Quizplus · Accepted Answer

From the graph, we see that the intersection between the line Y = AE and the potential GDP line (the dotted line) occurs at GDP2, which is $500 billion. Currently, the economy is at GDP1, which is $450 billion. The difference between these two is $50 billion, which is the output gap. To close this gap, we need to increase autonomous spending by an amount equal to the multiplier times the output gap. The multiplier is equal to 1 / (1 - MPC), which is 1 / (1 - 0.8) = 5. Therefore, the required increase in autonomous spending is 5 * $50 billion = $250 billion. However, we only need to find the change in autonomous spending, not its absolute value. Since we want to increase autonomous spending, we need a negative change, so the answer is -$10 billion (Choice C).

Figure 88 Alt Text for Figure 8