If the economy is in equilibrium and the government increases spending by $100 billion, equilibrium aggregate expenditures increase to $________ billion.Group of answer choices1,7001,8002,0002,400
Question
If the economy is in equilibrium and the government increases spending by ________ billion.Group of answer choices1,7001,8002,0002,400
Solution
To answer this question, we need to understand the concept of the multiplier effect in economics. The multiplier effect refers to the increase in final income arising from any new injection of spending.
The size of the multiplier depends upon household’s marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps). It is important to understand that these are ‘marginal’ propensities i.e. what households do with small changes in income, not necessarily what they do with a very large change in income.
If mpc is 0.8, then 80% of additional income is spent and 20% is saved. In this case, the multiplier is 1/(1-mpc) = 1/0.2 = 5.
So, if the government increases spending by 100 billion = $500 billion.
However, without knowing the mpc in this scenario, it's impossible to give a specific answer from the choices provided. The answer would be the original equilibrium aggregate expenditures plus $500 billion.
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