Suppose that Congress and the President are considering an i

Suppose that Congress and the President are considering an increase in government expenditures of $50 billion. They consult with two economists: Alan and Robert. Alan believes that the marginal propensity to consume (MPC) is 0.9 and Robert believes that it is 0.5 If Alan is correct, then the increase in government spending will cause GDP to increase by ____, and if Robert is correct, then the government spending increase will cause GDP to increase by ____ (B)

A. $450 billion, $250 billion

B.$500 billion, $100 billion

C.$250 billion, $150 billion

D.$150 billion, $250 billion

E.$45 billion, $25 billion

The answer is B, please explain why.

Solution

Ans: $500 billion, $100 billion

Explanation:

According to Alan:

MPC = 0.9

Government expenditure multiplier = 1 / (1 - MPC)

= 1 / (1 - 0.9)

= 10

Increase in GDP = $50 billion * 10 = $500 billion

According to Robert:

MPC = 0.5

Multiplier = 1 / (1 - 0.5) = 2

Increase in GDP = $50 * 2 = $100 billion