Question

Suppose that the fiscal policy multiplier is 8.6. What is MPC? Use that MPC and assume...

Suppose that the fiscal policy multiplier is 8.6. What is MPC? Use that MPC and assume that there is no crowding out in this economy. If the federal government knows that it will take a $750 billion rightward shift in AD to end a recession, how much does government spending need to be raised to accomplish that?

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Answer #1

Formula :

Fiscal Policy multiplier = 1/(1 - MPC) and it is given that Fiscal Policy multiplier = 8.6

=> 1/(1 - MPC) = 8.6 => MPC = 1 - 1/8.6 = 0.88

Hence, MPC = 0.88

Here Multiplier = 8.6 means that $1 increase in autonomous expenditure(like government spending) will result in increase in Real Output by 8.6 and hence will shift AD curve to the right by 8.6(Considering there is no crowding out).

Thus In order to shift AD to the right by 750 billion, Government will have to increase spending by (750 billion)/8.6 = 87.21 billion (approx)

Hence, government spending need to be raised by $87.21 billion

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