Macroeconomics 1st Edition by Dean Karlan,Jonathan Morduch

Exercise 15

Let's say that the government estimates that the average household spends 80 percent of each additional dollar of income and uses this estimate to determine the amount it needs to increase government spending to stimulate the economy by a given dollar amount. However, in reality, households actually spend 90 percent of each additional dollar of income. How will this affect expansionary fiscal policy via government spending? Will the amount of government spending calculated with the 80 percent figure be too much, too little, or just right? What will be the likely effect on output and employment in the short run?