No Bull Economics Lessons

Macroeconomics & Microeconomics Concepts You Must Know

AD/AS and Fiscal Policy (8 of 10)

Question 8:
Suppose that the marginal propensity to save is 0.2 for a closed economy with lump-sum taxes. If the government increases spending $75 million, real GDP could increase by a maximum of:

A.  $60 million
B.  $100 million
C.  $250 million
D.  $300 million
E.  $375 million

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Correct Answer: D, $375 million. The spending multiplier is 1/MPS (1/0.2 = 5). To get the increase in output, multiply the initial change in spending by the multiplier ($75 million x 5 = $375 million).