Question:
Assume that the marginal propensity to consume in a certain economy is 0.8 and equilibrium real Gross Domestic Product falls short of full employment real Gross Domestic Product by Rs. 1 000 billion. What is the amount by which the government should increase its purchases to raise economy’s real Gross Domestic Product to reach the full employment income level?
(1) Rs. 150 billion
(2) Rs. 200 billion
(3) Rs. 250 billion
(4) Rs. 300 billion
(5) Rs. 350 billion
Correct Answer:
(2)
Answer Explanation:
The GDP gap is 1000. To close this gap using government spending, we use the government spending multiplier, which is 1 / (1 – MPC). With an MPC of 0.8, the multiplier is 1 / 0.2 = 5. The required increase in government spending = GDP Gap / Multiplier = 1000 / 5 = 200.
Topic: Fiscal Policy Year: 2022
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