This exercise will test your students' understanding of the spending multiplier and its relationship to GDP. When assigning the exercise be sure to emphasize the importance of these concepts to understanding business cycles and macroeconomic equilibrium.

Form the class into pairs of students. Each pair works on the following questions:

What is the spending multiplier if the MPC = .8 and the MPI = 0?

Answer: 5

Given the multiplier found in question 1, if potential real GDP equals $800 billion and current real GDP equals $700 billion, what is the size of the recessionary gap?

Answer: $20 billion

How much would investment spending, exports, or government spending have to increase to make current real GDP equal to potential real GDP?

Answer: With a spending multiplier of 5, if AE rise by $20 billion, equilibrium income rises by the $100 billion necessary to close the GDP gap.

The instructor will call on different pairs of students for their answers.