Question

If MPC = 0.9, equilibrium real GDP is $1,000, and full-employment real GDP is $2,000, then how much should government spending change to bring about full employement?

Answer 1

Answer: $ 100

Explanation:

Equilibrium real GDP = $ 1000

Equilibrium Full employment GDP = $ 2000

So there is a gap of $ 1000 less to achieve full employment GDP.

First calculate multiplier,

Multiplier = 1/ (1-MPC) = 1/ (1- 0.9) = 1/ .1 = 10

With a multiplier of 10 , the government will spend $ 100 ( $1000 / 10) to achieve $ 1000 increase in GDP.

Multiplier of 10 means , every additional $ 1 spending by government will lead $ 10 increase in total spending & output.