Assume that the MPC is 0.75, full employment is considered to be at a GDP level of $500 billion, and the GDP is $600 billion. What should the government do to achieve full employment?
A) reduce spending by $25 billion
B) reduce spending by $100 billion
C) increase spending by $25 billion
D) increase spending by $10 billion

Question

Quizplus · Accepted Answer

To achieve full employment when the GDP is above the desired level, the government needs to reduce aggregate demand. With an MPC (marginal propensity to consume) of 0.75, the spending multiplier is 1/(1-MPC) = 4. To reduce GDP by $100 billion (from $600 billion to the full employment level of $500 billion), the government should reduce spending by $100 billion / 4 = $25 billion.

Assume That the MPC Is 0