Suppose that in the figure to the right, the government knows that the MPC is eq

Question

Suppose that in the figure to the right, the government knows that the MPC is equal to 0.800.80 and that the amount of the horizontal distance that the AD curve had to be shifted directly leftward from point Upper E 1E1 was equal to $1.751.75 trillion. What is the reduction in real government spending required to have generated this shift? Therefore, the reduction in real government spending necessary to shift the AD curve leftward by $1.751.75 trillion is $ nothing trillion. (Enter your response rounded to two decimal places.)

Explanation / Answer

MPC = .8

Hence, the spending multiplier = 1/(1-MPC) = 1/(1-.8)

Spending multiplier = 1/.2 = 5

Size of the leftwards shift in AD = $1.75 trillion

Reduction in real government spending required = 1.75/5

Reduction in real government spending required = $.35 trillion

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