The U.S. economy slowed significantly in early 2008, and policy makers were extremely concerned about growth. To boost the economy, Congress passed several relief packages (the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009) that combined would deliver about $700 billion in government spending. Assume, for the sake of argument, that this spending was in the form of payments made directly to consumers. The objective was to boost the economy by increasing the disposable income of American consumers.
Calculate the initial change in aggregate consumer spending as a consequence of this policy measure if the marginal propensity to consume (MPC) in the United States is 0.5.
Then calculate the resulting change in real GDP arising from the $700 billion in payments.
Gross Domestic Product:
Gross Domestic Product is a sum total of all the services and goods that have been produced in a country. Gross Domestic Product is a measurement of economic growth of a country.
Answer and Explanation:
Amount of government spending = $700 billion
Marginal propensity to consume = 0.5
Initial increase in aggregate consumer spending = $700 billion * 0.5 = $350 billion
Thus, this policy measure will initially increase the aggregate consumer spending by $350 billion.
Multiplier = 1/ (1-MPC) = 1/ (1-0.5) = 2
Increase in real GDP = Initial increase in aggregate consumer spending * Multiplier
Increase in real GDP = $350 billion * 2 = $700 billion
Thus, real GDP will increase by $700 billion due to stated policy measure.
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from Economics 102: MacroeconomicsChapter 4 / Lesson 3