Question

Suppose real gdp is 13.2 and potential real gdp is 14.0, with a gap of $800 billion. The government purchases multiplier is 5.0, and the tax multiplier is 4.0. How much will government purchases need to be increased to bring economy to equilibrium at potential GDP?

Answer 1

Answer: $160 billion

Explanation:

The government purchases multiplier refers to the increase in real GDP in dollar terms as a result of a dollar of government purchases in the economy. For instance, if the multiplier is 5 and the government spends $10, real GDP increases by: 5 * 10 = $50

The gap here is $800 billion. Given a government purchases multiplier of 5.0, the amount that the government needs to spend is:

= Gap / Multiplier

= 800 / 5

= $160 billion