The multiplier effect of a change in government purchases Suppose there is some hypothetical closed economy in which households spend $0.75 of each additional dollar they earn and save the remaining $0.25. The marginal propensity to consume (MPC) for this economy is (0.25 or 0.75 or 1 or 1.33 or 4), and the spending multiplier for this economy is (0.25 or 0.75 or 1 or 1.33 or 4). Suppose the government in this economy decides to decrease government purchases by $250 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to (-$1,000 billion or -$187.5 billion or -$93.8 billion or - $62.5 billion or -500 billion). This decreases income yet again, leading to a second change in consumption equal to (- $93.8 billion or - 1,000 billion or - $500 billion or - $140.6 billion or -62.5 billion). The total change in demand resulting from the initial change in government spending is (-$1 trillion or - $1.9 trillion or - $0.8 trillion or - $0.5 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

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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The multiplier effect of a change in government purchases

Suppose there is some hypothetical closed economy in which households spend $0.75 of each additional dollar they earn and save the remaining $0.25.

The marginal propensity to consume (MPC) for this economy is (0.25 or 0.75 or 1 or 1.33 or 4), and the spending multiplier for this economy is (0.25 or 0.75 or 1 or 1.33 or 4).

Suppose the government in this economy decides to decrease government purchases by $250 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to (-$1,000 billion or -$187.5 billion or -$93.8 billion or - $62.5 billion or -500 billion). This decreases income yet again, leading to a second change in consumption equal to (- $93.8 billion or - 1,000 billion or - $500 billion or - $140.6 billion or -62.5 billion). The total change in demand resulting from the initial change in government spending is (-$1 trillion or - $1.9 trillion or - $0.8 trillion or - $0.5 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.

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

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