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Suppose the economy is at equilibrium when business firms decide to increase investment spending by $100...

Suppose the economy is at equilibrium when business firms decide to increase investment spending by $100 billion. According to the short-run Keynesian model, what would be the effect of the change in investment spending on equilibrium real GDP?

a.         nothing; the increased investment spending would be offset by decreased spending in other sectors

b.         it would increase by $100 billion

c.         it would increase by more than $100 billion

d.         it would increase, but by less than $100 billion

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Answer #1

The Nominal GDP can be defined the market value of all goods and services which are produced in the domestic territory of the country in the current financial years.

GDP=C+I+G+X-M

Spending multiplier=1/MPS

As it has been given that the economy is initially at equilibrium when business firms decide to increase investment spending by $100 billion.

So with the increase in the investment new equilibrium will increase by= spending multiplier* change in investment

Hence the equilibrium level of GDP will increase by more than $100 due to multiplier effects.

Hence option c is the correct answer.

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