An economy is currently producing real GDP that is $\$ 500$ billion more than its full employment output. It is also experiencing an undesirable amount of inflation. Its marginal propensity to consume is 0.75 .

Assuming that this is a closed economy with no crowding out, which of the following best describes the impact that a $\$ 100$ billion increase in government spending will have on this economy?

Choose 1 answer:
(A) Aggregate demand and real output will eventually increase by only $\$ 400$ billion, and the price level will increase
(B) Aggregate demand and real output will eventually increase by only $\$ 300$ billion, and the price level will increase
(C) Aggregate demand and real output will eventually increase by only $\$ 300$ billion, and the price level will decrease
(D) Aggregate supply and real output will eventually increase by only $\$ 200$ billion, and the price level will decrease
(E) Aggregate supply and real output will eventually increase by only

Question

An economy is currently producing real GDP that is $\$ 500$ billion more than its full employment output. It is also experiencing an undesirable amount of inflation. Its marginal propensity to consume is 0.75 .

Assuming that this is a closed economy with no crowding out, which of the following best describes the impact that a $\$ 100$ billion increase in government spending will have on this economy?

Choose 1 answer:
(A) Aggregate demand and real output will eventually increase by only $\$ 400$ billion, and the price level will increase
(B) Aggregate demand and real output will eventually increase by only $\$ 300$ billion, and the price level will increase
(C) Aggregate demand and real output will eventually increase by only $\$ 300$ billion, and the price level will decrease
(D) Aggregate supply and real output will eventually increase by only $\$ 200$ billion, and the price level will decrease
(E) Aggregate supply and real output will eventually increase by only

Accepted Answer

∻Solution by Steps∻ ‖ step 1 ⋮ To determine the impact of government spending on aggregate demand, we use the government spending multiplier formula: $Multiplier = \frac{1}{1 - MPC}$, where MPC is the marginal propensity to consume. ‖ ‖ step 2 ⋮ Given that the MPC is 0.75, we calculate the multiplier: $Multiplier = \frac{1}{1 - 0.75} = 4$. ‖ ‖ step 3 ⋮ To find the total change in aggregate demand, we multiply the change in government spending by the multiplier: $Change in Aggregate Demand = Multiplier imes Increase in Government Spending$. ‖ ‖ step 4 ⋮ Substituting the given values: $Change in Aggregate Demand = 4 imes \$100$ billion = \$400$ billion. ‖ ‖ step 5 ⋮ Since the economy is already above full employment output, the increase in aggregate demand will primarily affect the price level rather than real output. ‖ ∻Answer∻ Provide the most correct one answer choice letter strictly in the following format enclosed by *** ***A*** ∻$**Key Concept∻ ⚹Government Spending Multiplier⚹ ∻Explanation∻ ⚹The government spending multiplier is used to estimate the total impact on aggregate demand from a change in government spending, taking into account the marginal propensity to consume.⚹◊What is the formula to calculate the impact of government spending on the economy in a closed economy with no crowding out?⍭ Generate me a similar question◊

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