Question

g Using the Multiplier Model (and assuming the price level is fixed), if the economy is operating at $3,000 billion and the government policymakers have determined that the target level of income to reach is $3,500 billion, by how much must they increase government spending by to eliminate the recessionary gap if the mpe

Answer 1

Answer: a. $200 billion

Explanation:

The Multiplier Effect (MPE) is used to calculate the Multiplier which then shows how much the GDP of the country will increase if a certain amount of money is induced into it.

The formula is;

Multiplier = 1 / ( 1 - MPE)

= 1 / ( 1 - 0.6)

= 2.5

The economy is now operating at $3,000 billion but they would want it to operate at $3,500 billion.

The difference of $500 billion is the amount that policy makers would like to add to the economy.

The Multiplier of 2.5 means that for every $1 spent, $2.5 will be added to the economy.

To get a $500 billion increase therefore, they would need to spend;

= 500 / 2.5

= $200 billion.

If they spend $200 billion, $500 billion will be added to the economy by the Multiplier Effect.