Answer:
The correct answer is: $1 trillion; $4 trillion.
Explanation:
The marginal propensity to consume is 0.8.
Government spending decreases by $1 trillion.
The real GDP will initially decline by the amount of decline in government spending.
So the decline in the real GDP will initially be $1 trillion.
The overall decrease in the real GDP will be by the size of the spending multiplier.
Total decrease in real GDP
= [tex]\Delta G \times \frac{1}{1-MPC}[/tex]
= [tex]\$ 1\times\frac{1}{1-0.8}[/tex]
= [tex]\$1 \times \frac{1}{0.2}[/tex]
= $5 trillion
Out of this $5 trillion decrease, $1 was initially decreased.
So decline in real GDP due to reduced consumption will be
= $5 trillion - $1 trillion
= $4 trillion
