1. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) for this economy is , and the spending multiplier for this economy is Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to . This decreases income yet again, causing a second change in consumption equal to . The total change in demand resulting from the initial change in government spending is The following graph shows the aggregate demand curve (AD₁) for this economy before the change in government spending. Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the spending multiplier effect takes place. Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD₁). You can see the slope of AD₁ by selecting it on the graph.

1. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) for this economy is , and the spending multiplier for this economy is Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to . This decreases income yet again, causing a second change in consumption equal to . The total change in demand resulting from the initial change in government spending is The following graph shows the aggregate demand curve (AD₁) for this economy before the change in government spending. Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the spending multiplier effect takes place. Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD₁). You can see the slope of AD₁ by selecting it on the graph.

ECON MACRO

5th Edition

ISBN:9781337000529

Author:William A. McEachern

Publisher:William A. McEachern

Chapter11: Fiscal Policy

Section: Chapter Questions

Problem 1.4P

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Question

PRICE LEVEL (CPI)
140
135
130
125
120
115
110
105
100
0
AD1
1
2
3
4
5
REAL GDP (Trillions of dollars)
6
7
8
AD2
?

1. The multiplier effect of a change in government purchases
Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20.
The marginal propensity to consume (MPC) for this economy is
and the spending multiplier for this economy is
Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will
lead to a decrease in income, generating an initial change in consumption equal to
This decreases income yet again, causing a
second change in consumption equal to
The total change in demand resulting from the initial change in government spending
is
The following graph shows the aggregate demand curve (AD₁ ) for this economy before the change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the spending multiplier effect takes place.
Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD₁ ). You can see the slope of AD₁ by
selecting it on the graph.

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3