Suppose that marginal propensity to consume is equal to 0.9 and the government increases its spending by $200 billion. This new increase in spending is financed by a fresh increase in taxes equal to $200 billion. As a result of this, GDP will:

A. not change at all.
B. increase by $200 billion.
C. increase by $2,000 billion.
D. decrease by $200 billion.

The answer is B.

Explanation:

Gross Domestic Product (GDP) is the total market value of all the final goods and services produced within a sovereign nation(country) during a given period of time usually a year.

Gross Domestic Product (GDP) can be calculated using expenditure method or income method or value-added method.

To analyze this question, expenditure method will be used. The formula is C + I + G + (X-M)

where C is the consumer spending

I is the business investments

G is the government spending

X is the exports

M is the imports.

Government has injected $200 billion into the economy through its spending.

This $200 billion is gotten from an increase in taxes, meaning consumers' disposable income has reduced by this amount.

Therefore, $200 billion will still be the incremental amount to the GDP