18) Assume that the full-employment level of output is $1,000 and the price leve

Question

18) Assume that the full-employment level of output is $1,000 and the price level associated with full-employment output is 100. Also assume that the economy's current level of output is $1,100 and, at the price level of 100, current aggregate demand is $1,200. If the government wants to move the economy back to the full-employment level of output and the MPC is 0.75, then it should A) reduce government expenditures by $25. B) reduce government expenditures by S50. C) reduce government expenditures by $200 D) reduce government expenditures by $100.

Explanation / Answer

18.

Correct Answer:

B.

Working note:

Required decrease in demand = present demand – demand at potential output = 1200-1000 = $200

Multiplier = 1/(1-MPC) = 1/(1-.75) = 4

Hence, decrease in government spending = 200/4 = $50

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