(Part A) Suppose your local Congress representative suggests that the federal government intervenes in the gasoline market to stop runaway price increases

(Part A): Government intervention to control prices is an aspect of neo-Keynesian thought. Keynesian economists (and others) are generally in favor of using the government to alter, and hopefully improve, resource allocations. This Congressperson from our question may suggest subsidies to consumers or producers in order to lower the price to customers and the production costs to seller. In either case, this would allocate resources toward gasoline consumption, but it would allocate resources away from other areas of consumption and capital investment. Another option would be a price ceiling on gasoline which has numerous effects, but in the end is a form of resource reallocation as well.

A Monetarist would probably argue differently. Monetarists tend to believe that price is the regulatory mechanism for markets and it will adjust on its own as production costs change or consumer preferences change. Price is the tool which creates an equilibrium between producer costs (the supply curve) and consumer utility (the demand curve). Although a Keynesian approach may lower the price paid at the pump, it does so by allocating spending and production away from other areas of the economy.

(Part B): One dollar in spending becomes one dollar in income for somebody else, who the turns around and spends it on something else. However, the second person doesn't spend the whole dollar (in general). This person saves part of it. This is called the marginal propensity to save. The GDP multiplier is 1 / MPS. Thus an increase in spending creates subsequent rounds of spending (subject to the savings leakage) and ultimately increases GDP by more than the initial spending.

(Part C): If consumers spend 80 cents out of each dollar, then they're saving the other 20 cents. Therefore, our MPS is 0.2 and our spending multiplier is 1 / 0.2 = 5. An increase in government purchases of $200 billion will ultimately create $1 trillion in spending (i.e. $200 billion * 5 = $1 trillion).