Question

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (b) of Figure 13-1, the government knows that the MPC is equal to 0.75 and that the amount of the horizontal distance that the AD curve had to be shifted directly leftward from point E1 was equal to $1.0 trillion. What is the reduction in real government spending required to have generated this shift?

Short answer

The reduction in real government spending required is$\$0.25$trillion

Step-by-step solution

introduction

Spending Multiplier: It is a proportion of the degree to which GDP changes because of an adjustment of arranged venture spending or government spending. Marginal Propensity to Consume alludes to the extent of the absolute expansion in discretionary cash flow that families give to utilization.

explanation

We know,

MPC = $0.75$

The spending multiplier can be calculated as,

role="math" localid="1651935485004" $\begin{array}{r}=\frac{1}{1-\mathrm{MPC}}\\ =\frac{1}{1-0.75}=4\\ \end{array}$

the decline in government expenditure be$∆G$and leftward shift on the AD curve be$∆AD$=$\$1$trilion

the decline in government expenditure

role="math" localid="1651935751198" $$\begin{gathered} \mathrm{\Delta G}=\frac{\mathrm{\Delta AD}}{\text{spending multiplier}} \\ =\frac{1}{4}=0.25 \end{gathered}$$

The reduction in real government spending required is$\$0.25$trillion