Government Consumption Gross Real GDP after taxes Investment

Government Consumption Gross Real GDP (after taxes) Investment Net Exports Purchases $10 $15 15 15 15 15 15 15 -$20 10 40 70 100 130 160 20 40 60 80 100 10 10 10 10 10 10 13 Refer to the table. A decrease in government purchases of $5 would Multiple Choice increase real GDP by $5 increase real GDP by $10 decrease real GDP by $5. decrease real GDP by $15

Solution

The change in real GDP due to a change in government spending will be equal to (m x change in govt. spending) where m is the multiplier.

m = 1 / MPS

MPS = 1 - MPC

MPC = Change in consumption / change in income

Here real GDP is the income. Hence,\'

MPC = 20 / 30 = 2 / 3

MPS = 1 - (2 / 3) = 1 / 3

m = 1 / (1/3) = 3

Thus the multiplier is 3.

So the total change in real GDP will be equal to = 3 x -$5 = - $15.

Answer: A $5 decrease in govt. purchases would lead to a decrease in the real GDP by $15. Hence the correct answer is (D).