Suppose the short-run equilibrium level of real GDP is $4,000 billion and the MP

Question

Suppose the short-run equilibrium level of real GDP is $4,000 billion and the MPC = 0.75. If full employment (natural) real GDP is $5,000 billion, what fiscal policy action could the government undertake to put the economy at full-employment equilibrium, according to the simple Keynesian model? Increase government spending by $250 billion or decrease taxes by $333.3 billion Increase both government spending and taxes by $333.3 billion Decrease taxes by $250 billion or increase government spending by $200 billion Decrease government spending by $250 billion or increase taxes by $333.3 billion

Explanation / Answer

Solution: Decrease taxes by $333.3 billion

Explanation:

full employment (natural) real GDP-short-run equilibrium level of real GDP

$5000-$4000=$1000

Multiplying this value with  MPC i.e $1000*0.75=$1333.33

Now, taxes should be reduced by $1333.33-$1000=$333.33

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