By how much would government spending have to increase to achieve the goal in the following scenario? Suppose that the MPC = 0.8 and that $14 trillion of real GDP is currently being demanded. The government wants to increase real GDP demanded to $15 trillion at the given price level.
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The recessionary gap is the difference between what the government desires and what is currently demanded. Since the government wants $15 trillion, and there is currently a demand of $14 trillion, there is a $1 trillion recessionary gap.
Now, to overcome this recessionary gap, we have to multiply it by the economic multiplier, which is the amount of change in the economy every dollar spent by the government will create. This is calculated by the following equation: 1/(1-MPC). We know the MPC is 0.8. Therefore, the multiplier is 1/(1-0.8) = 5.
To calculate the spending necessary, then, we know that we need a certain amount spent which, when multiplied by 5, will equal the $1 trillion recessionary gap. If...
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The government wants to increase real GDP $1trillion.
The government has to increase spending=1/5=$0.2 trillion or 0.2x1,000=200billion.
The multiplier=1/1-MPC=1/1-0.8=1/0.2=5
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