Which of the following explains why a $100 billion reduction in consumption spending might decrease equilibrium real GDP by more than $100 billion?
A) Say's law.
B) The quantity theory of money.
C) Flexible resource prices.
D) The multiplier principle.

Question

Quizplus · Accepted Answer

The multiplier principle states that a change in autonomous spending (such as a decrease in consumption spending) will result in a larger change in equilibrium real GDP due to the effects of the spending multiplier. Specifically, the spending multiplier is equal to 1/(1-MPC), where MPC is the marginal propensity to consume. If we assume a MPC of 0.5 (which is a typical value), then a $100 billion decrease in consumption spending would result in a decrease in equilibrium real GDP of $200 billion ($100 billion divided by 1-0.5). Therefore, the decrease in consumption spending would have a larger effect on equilibrium real GDP than the initial amount of the spending reduction.

Which of the Following Explains Why a $100 Billion Reduction