An economy is experiencing inflationary pressure with a current equilibrium national incom… — JAMB UTME

An economy is experiencing inflationary pressure with a current equilibrium national income ( $Y$ ) of $₦850\text{ billion}$ and a full-employment potential national income ( $Y_f$ ) of $₦730\text{ billion}$ . If the economy's Marginal Propensity to Save ( $MPS$ ) is $0.2$ , calculate the required change in government expenditure ( $\Delta G$ ), in billions of Naira, needed to achieve economic stabilization.

Answer: -24 billion Naira

Answer

Government expenditure must be changed by -24 billion Naira (a reduction of 24 billion Naira).

To close an inflationary gap of 120 billion Naira when the Marginal Propensity to Save is 0.2, the spending multiplier is calculated as 1 / 0.2 = 5. Dividing the aggregate demand reduction of -120 billion Naira by the multiplier of 5 gives a required change in government expenditure of -24 billion Naira.

Step-by-Step Solution

Determine the output gap to be closed

\Delta Y = 730 - 850 = -120\text{ billion Naira}

To eliminate the inflationary gap and stabilize the economy at full employment (

Y_f

), aggregate national output must decrease by 120 billion Naira.

Calculate the government expenditure multiplier (

K_g

)

K_g = \frac{1}{MPS} = \frac{1}{0.2} = 5

The expenditure multiplier measures the magnified impact of autonomous government spending on national income, calculated as the reciprocal of the Marginal Propensity to Save.

Calculate the required change in government spending (\Delta G)

\Delta G = \frac{\Delta Y}{K_g} = \frac{-120}{5} = -24\text{ billion Naira}

Dividing the desired change in aggregate output by the spending multiplier determines the contraction in government spending needed for stabilization.

Key Concept

Government Expenditure Multiplier and Inflationary Gap Stabilization

Question

Answer

Step-by-Step Solution

Key Concept

Common Mistakes

Topics

More questions from this topic