Consider a 2sector Keynesian economy that has a multiplier

. Consider a 2-sector Keynesian economy that has a multiplier of 4. A 1 percent fall (rise) in the real interest rate leads to a rise (fall) in consumption of 6, and a rise (fall) in planned investment of 9. If potential output is 3000 and actual output is 2880 then, all other things being equal, the central bank could correct the output gap by: a. b. c. d. Raising the real interest rate by 4 percent Reducing the real interest rate by 4 percent Raising the real interest rate by 2 percent Reducing the real interest rate by 2 percent

Solution

3. Option d- reduce real interest rate by 2%

Output gap = Potential output - actual output
= 3000 - 2880
= 120

The multiplier is 4. So the spending must increase by 120/4 = 30 units.

We know that 1% fall in real interest rate leads to increase in spending by 6 + 9 = 15 units.
Then, a 2% fall should increase the spending by 2*15 = 30 units

PS: According to Chegg rules, the event of multiple numerical questions, only the first one is attempt