Initially,the economy is in long-run equilibrium.Aggregate demand then shifts leftward by $50 billion.The government wants to increase its spending in order to avoid a recession.If the crowding-out effect is always one-third as strong as the multiplier effect,and if the MPC equals 0.6,then by how much do government purchases have to increase in order to offset the $50 billion leftward shift?
A)by $90 billion
B)by $60 billion
C)by $20 billion
D)by $30 billion

Question

Quizplus · Accepted Answer

The multiplier is calculated as 1/(1-MPC) = 1/(1-0.6) = 2.5. The crowding-out effect is one-third of the multiplier effect, so the net multiplier is 2.5 - (1/3 * 2.5) = 1.67. To offset a $50 billion shift, government spending must increase by $50 billion / 1.67 ≈ $30 billion.

Initially,the Economy Is in Long-Run Equilibrium