Question

In an economy, the government wants to increase aggregate demand by $50 billion at each price level to increase real GDP and reduce unemployment. If the MPS is .4, then it could increase government spending by: 
A. $10 billion
B. $20 billion
C. $31.25 billion
D. $40.50 billion

Answer 1

Answer: $20 BILLION

Explanation: Increase in govt. purchases can be calculated as follows :-

$\triangle\:G =\frac{\triangle\:AD}{Multiplier}$

where,

Multiplier =  1/MPS

Multiplier =  1/0.4

                = 2.5

ΔG =  change in spending

ΔAD =  change in aggregate demand

now, putting the values in equation we get :-

$\triangle\:G =\frac{\ 50}{2.5}$

                          = $20 billion