Question

20. Given the following macroeconomic data of a hypothetical economy:

-- actual real GDP = $3,000
-- full-employment real GDP = $4,500
-- the economy's Consumption Function is C = 350 + 0.75 (DI)  

How much must the government spend in order to close up such recessionary GDP gap?

1. $550

2. $400

3. cannot be computed based on information provided

4. $375

5. $1,500

Answer 1

MPC=change in consumption / change in disposable income

MPS=1-MPC

Spending Multiplier=1/MPS

actual real GDP = $3,000
full-employment real GDP = $4,500
the economy's Consumption Function is C = 350 + 0.75 (DI)  

MPC=0.75

MPS=1-MPC

=1-0.75

=0.25

Spending multiplier=1/MPS

=1/0.25

=4

The recessionary gap= full employment GDP- actual real GDP

=4500-3000

=1500

The required increase in the G for filling this gap is= gap/ spending multiplier

=1500/4

=$375

Hence option 4 is the correct answer.