Suppose the MPC of Banana Republic is 9 and the country is i

Suppose the MPC of Banana Republic is .9 and the country is in recession. The government wishes to get out of the recession through a massive expenditure program. If the recessionary gap is 900 million Euros, how much will the government need to spend?

Solution

The country\'s incomes fall short by 900 million euros , thus to close the recessionary gap it needs to increase the total output by 900 million euros.Given the MPC = 0.9 the government needs to increase spending by 90 million euros .This is because given the value of MPC = 0.9 value of government multiplier = 1/1 - MPC = 1/ 1 - 0.9 = 1/.1 = 10.

Thus if government increases spending by 90 million euros the total income increases by 90 * 10 = 900 million euros and the recessionary gap ends .Thus the economy again reaches full employment.