Question

An economy is operating with output $200 billion above its natural level, and fiscal policymakers want to close this expansionary gap. The central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding out. The marginal propensity to consume is 3/4, and the price level is completely fixed in the short run.

To close the expansionary gap, the government would need to decrease or increase spending by ?? billion.

Answer 1

Now to close the inflationary gap government has to decrease the spendings

Now the multiplier is 1/1/4= 4 this is 1/MPS

So government spendings has to be decreased by 200/4= 50 billion