Assume that the GDP gap is 100 and the economy is in a recession. If the MPC is .75, how much should the government increase spending to eliminate the gap?
Answer: using the formula: 1/(1-MPC), the spending multiplier is 4. The government should spend 25 to eliminate the gap (100/4).
How much should the government decrease taxes? If you answered 33.33, then you knew that the tax multiplier was -MPC/MPS or -3.
Discussion question: Does Fiscal Policy work?