If the government purchases multiplier equals 2, and real GDP is $14 trillion with potential GDP of $14.5 trillion, then government purchases would need to increase by $250 billion to restore the economy to potential GDP.

Question

BlackTom AI · Accepted Answer

We start by identifying the economic gap and the given multiplier effect. The potential GDP is 14.5 trillion and actual GDP is 14 trillion, so the GDP gap is 0.5 trillion (500 billion). The government purchases multiplier is 2, meaning a $1 increase in government spending raises real GDP by $2.

Option 1: True. To close a 0.5 trillion GDP gap using a multiplier of 2, the required change in autonomous government purchases is GDP gap divided by the multiplier: 0.5 trillion / 2 = 0.25 trillion, which equals 250 billion. Therefore, increasing government purchases by 250 billion would, in theory, restore the economy toward potential GDP.

Option 2: False. This would be incorrect because the calculation above shows that the needed spending increase is 250 billion, not any other amount. If someone argued a different amount, they would be misapplying either the size of the GDP gap, the multiplier, or both. It's also worth noting that this analysis assumes a simple, closed-loop Keynesian framework where the multiplier works as specified and there are no offsetting crowding-out effects or other constraints.

In sum, the arithmetic aligns with a 0.5 trillion GDP shortfall and a multiplier of 2, yielding a 0.25 trillion (250 billion) required increase in government purchases to move toward potential GDP.

If the government purchases multiplier equals 2, and real GDP is $14 trillion with potential GDP of $14.5 trillion, then government purchases would need to increase by $250 billion to restore the economy to potential GDP.

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