Answered: PRICE LEVEL 140 135 AD A 130 125 120…

Principles of Economics 2e

2nd Edition

ISBN:9781947172364

Author:Steven A. Greenlaw; David Shapiro

Publisher:Steven A. Greenlaw; David Shapiro

Chapter22: Inflation

Section: Chapter Questions

Problem 18RQ: What is deflation?

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3. The multiplier effect of a change in government purchases

Suppose there is some 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 is0.8 , and the spending multiplier for this economy is5 .

Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to-$240 billion . This decreases income yet again, leading to a second change in consumption equal to-$192 billion . The total change in demand resulting from the initial change in government spending is-$1.5 trillion .

The following graph shows the aggregate demand curve (AD1AD1) for this economy before the change in government spending.

Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2AD2) after the multiplier effect takes place. For simplicity, assume that there is no "crowding out."

Hint: Be sure that the new aggregate demand curve (AD2AD2) is parallel to the initial aggregate demand curve (AD1AD1). You can see the slope of AD1AD1 by selecting it on the graph. -----My problem I have is that I can't put 132.5 as my Price Level, so it's either 130 or 135 but I don't wanna be wrong. please help me if i cant put 132.5.