Suppose the price level is ﬁxed, the MPC is 0.8, and the GDP gap is a negative $200 billion. To achieve full-employment output (exactly), government should
A) increase government expenditures by $200 billion.
B) reduce taxes by $200 billion.
C) increase government expenditures by $40 billion.
D) reduce taxes by $160 billion.

Question

Quizplus · Accepted Answer

Given the MPC (marginal propensity to consume) is 0.8, the multiplier is 1/(1-MPC) = 5. To close a GDP gap of $200 billion, the government needs to increase spending by $200 billion / 5 = $40 billion.

Suppose the Price Level Is ﬁXed, the MPC Is 0