Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and aggregate expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph. The first economy's MPC is 0.5. Therefore, its initial aggregate expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy's MPC is 0.75. Therefore, its initial aggregate expenditure line has a slope of 0.75 and passes through the point (100, 100). Now, suppose there is an increase of $20 billion in investment in each economy. Place a green line (triangle symbol) on each of the previous graphs to indicate the new aggregate expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical axis intercept of a line on the graph by selecting it.) AGGREGATE EXPENDITURE (Bilions of dollars) AGGREGATE EXPENDITURE (Bilions of dollars) 200 180 160 120 100 80 60 140 120 100 20 0 0 A Line A A Life 40 MPC-0.5 45-Degree Line 80 100 120 REAL GDP (Bilions of dollars) MPC 0.75 160 180 45-Degree Line 100 REAL GDP (Bilions of dollars) 160 200 New AE Line New Equilibrium New AE Line New Equilibrium ? ?
Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and aggregate expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph. The first economy's MPC is 0.5. Therefore, its initial aggregate expenditure line has a slope of 0.5 and passes through the point (100, 100). The second economy's MPC is 0.75. Therefore, its initial aggregate expenditure line has a slope of 0.75 and passes through the point (100, 100). Now, suppose there is an increase of $20 billion in investment in each economy. Place a green line (triangle symbol) on each of the previous graphs to indicate the new aggregate expenditure line for each economy. Then place a black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical axis intercept of a line on the graph by selecting it.) AGGREGATE EXPENDITURE (Bilions of dollars) AGGREGATE EXPENDITURE (Bilions of dollars) 200 180 160 120 100 80 60 140 120 100 20 0 0 A Line A A Life 40 MPC-0.5 45-Degree Line 80 100 120 REAL GDP (Bilions of dollars) MPC 0.75 160 180 45-Degree Line 100 REAL GDP (Bilions of dollars) 160 200 New AE Line New Equilibrium New AE Line New Equilibrium ? ?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with
real GDP and aggregate expenditure equal to $100 billion, as shown by the black points on the following two graphs. Neither economy has taxes that
change with income. The grey lines show the 45-degree line on each graph.
The first economy's MPC is 0.5. Therefore, its initial aggregate expenditure line has a slope of 0.5 and passes through the point (100, 100).
The second economy's MPC is 0.75. Therefore, its initial aggregate expenditure line has a slope of 0.75 and passes through the point (100, 100).
Now, suppose there is an increase of $20 billion in investment in each economy.
Place a green line (triangle symbol) on each of the previous graphs to indicate the new aggregate expenditure line for each economy. Then place a
black point (plus symbol) on each graph showing the new level of equilibrium output. (Hint: You can see the slope and vertical axis intercept of a line
on the graph by selecting it.)
AGGREGATE EXPENDITURE (Billions of do
200
180
160
140
120
100
80
60
40
20
0
20
AE Line
0
0 20
40
+
20
MPC=0.5
MPC=0.75
200
45-Degree Line
180
160
140
120
R
100
80
60
40
AE Line
45-Degree Line
60 80 100 120 140 160 180 200
REAL GDP (Billions of dollars)
40 60 80 100 120 140 160 180 200
REAL GDP (Billions of dollars)
New AE Line
+
+
New Equilibrium
New AE Line
++
New Equilibrium
(?)
(?
Transcribed Image Text:billion. In the second
In the first economy (with MPC = 0.5), the $20 billion increase in investment causes equilibrium output to increase by S
economy (with MPC = 0.75), the $20 billion increase in investment causes equilibrium output to increase by S billion. Therefore, a higher MPC
is associated with a
▼ multiplier.
Now, confirm your graphical analysis algebraically using the formula for the simple spending multiplier:
Multiplier = MIC
For the first economy with an MPC of 0.5, the effect of the $20 billion increase in investment becomes the following:
Change in Equilibrium Output = Change in Aggregate Expenditure x Multiplier
x
Using the same method, the multiplier for the second economy is
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