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14 October, 01:19

Real GDP equals $200 billion, the government collects 20% of any increase in real GDP in the form of taxes, and the marginal propensity to consume is 0.8. If the government increases spending by $10 billion, real GDP will increase by:

A) $10 billion.

B) $20 billion.

C) $27.8 billion.

D) $50 billion.

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Answers (1)
  1. 14 October, 04:41
    0
    If he government increases spending by $10 billion, real GDP will increase by $27.8 billion. The right answer is C.

    Explanation:

    In order to calculate how much the real GDP will increase, we have to calculate the Expenditure multiplier with the following formula:

    Expenditure Multiplier = [1 / (1-MPC (1-tax) ]

    Expenditure Multiplier = [1 / (1-0.8 (1-0.2) ]

    Expenditure Multiplier = [1 / (1-0.8 (0.8) ]

    Expenditure Multiplier = [1 / (0.36) ]

    Expenditure Multiplier = 2.778

    So, an increase in G by $10 billion will increase real GDP by $10 x 2.778 = $27.8 billion.
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