If policy makers want to decrease real GDP by $100 billion and the marginal propensity to consume is 0.6, they should decrease government purchases of goods and services by $40 billion.

Question

Quizplus · Accepted Answer

The multiplier effect states that a change in government spending will have a multiplied effect on real GDP. The multiplier is equal to 1/(1-MPC), where MPC is the marginal propensity to consume. In this case, the MPC is 0.6, so the multiplier is 1/(1-0.6) = 2.5. This means that a decrease in government spending of $40 billion will lead to a decrease in real GDP of $40 billion * 2.5 = $100 billion.

If Policy Makers Want to Decrease Real GDP by $100