Suppose the economy is in a recession The economy needs to e

Suppose the economy is in a recession. The economy needs to expand by at least $300 billion and the marginal propensity to consume is 0.8.

What is the least amount the government can spend to overcome the $300 billion gap?

Solution

MPC = 0.8

Multiplier = 1/(1-MPC) = 1/(1-0.8) = 1/0.2 = 5

Required change in money supply = $300 billion

Investment needed = Expansion/Multiplier = $300 billion/5 = $60 billion

Thus, the least amount the government can spend to overcome the $300 billion gap = $60 billion