Refer to Figure 23-3. Suppose that government spending increases,shifting up the aggregate expenditure line. GDP increases from GDP₁ to GDP₂,and this amount is $200 billion. If the MPC is 0.8,then what is the distance between N and L or by how much did government spending change?
A) $16 billion
B) $40 billion
C) $200 billion
D) $1,000 billion

Question

Quizplus · Accepted Answer

The distance between point N and point L represents the change in government spending. The distance between GDP₁ and GDP₂ is equal to $200 billion.

We know that MPC (marginal propensity to consume) is 0.8. Therefore, the multiplier is equal to 1/(1-MPC) = 1/(1-0.8) = 5.

To find out the change in government spending, we can use the expenditure multiplier:

Change in GDP = Multiplier x Change in Government Spending
$200 billion = 5 x Change in Government Spending
Change in Government Spending = $40 billion

Therefore, the correct answer is B.