5. The multiplier effect of a change in government purchases 5. The multiplier effect of a change in government purchasesSuppose 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 is, and the spending multiplier for this economy isSuppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government spending will leadto a decrease in income, creating an initial change in consumption equal toThis decreases income yet again, leading to asecond change in consumption equal toThe total change in demand resulting from the initial change in government spending isThe 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 multiplier effect takes place. For simplicity, assume thatthere is no "crowding out."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 byselecting it on the graph.*********** 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 multiplier effect takes place. For simplicity, assume thatthere is no "crowding out."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 byselecting it on the graph.PRICE LEVEL1401351301101051000AD16OUTPUT (Trillions of dollars)AD

Marginal propensity to consume measures the change in consumption spending due to change in income. Multiplier = 1 / (1-MPC) Household spend $0.80 of each additional dollar they earn and save the remaining $0.20. It means MPC is 0.80 => Multiplier = 1/ (1-MPC) => Multiplier = 1/ (1-0.8) => Multiplier = 1/0.2 => Multiplier = 5 ------------------------ The marginal propensity to consume for this economy is 0.80, and the spending multiplier for this economy is 5 -------------------------Government purchases decreases by $300 billion This decrease in government purchases will decrease the income by $300 billion. => Initial change in income = -$300 billion MPC = (Change in consumption / Change in income) => 0.80 = (Change in consumption / -$300 billion) => Change in consumption = 0.80 * (-$300 billion) = -$240 billion Hence, the initial change in consumption is -$240 billion --------------- The initial change in consumption by -$240 billion will decrease the income again by $240 billion. => Second change in income = -$240 billion MPC = (Change in consumption / Change in income) => 0.80 = (Change in consumption / -$240 billion) => Change in consumption = 0.80 * (-$240 billion) => Change in consumption = -$192 billion Hence, the second change in consumption is -$192 billion --------------- Total change in demand = Multiplier * Initial change in government purchases => Total change in demand = 5 * (-$300 billion) => Total change in demand = -$1500 billion => Total change in demand = -$1.5 trillion ----------- 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 -$240 billion. This decreases income yet again, causing 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 total change in demand resulting from the initial change in government spending is -$1.5 trillion. And there is no crowding out. This will shift the AD curve leftward by -$1.5 trillion at each price level. ---------------------------------------------

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uppose there is some hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining 0.20. he marginal propensity to consume (MPC) for this economy is Y 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 spending will lead co a decrease in income, creating an initial change in consumption equal to M This decreases income yet again, leading to a second change in consumption equal to ▼ The total change in demand resulting from the initial change in government spending is

uppose there is some hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining 0.20. he marginal propensity to consume (MPC) for this economy is Y 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 spending will lead co a decrease in income, creating an initial change in consumption equal to M This decreases income yet again, leading to a second change in consumption equal to ▼ The total change in demand resulting from the initial change in government spending is

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Chapter1: Making Economics Decisions

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5. The multiplier effect of a change in government purchases

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 multiplier effect takes place. For simplicity, assume that
there is no "crowding out."
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.
PRICE LEVEL
140
135
130
110
105
100
0
AD
1
6
OUTPUT (Trillions of dollars)
AD

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2. 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…
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4. 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 is 0.8 and the spending multiplier for this economy is 5 Suppose the government in this economy decides to decrease government purchases by $400 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to This decreases income yet again, leading to 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 (AD) for this economy before the change in government spending Use the green line (triangle symbol) to plot the new aggregate demand curve (AD) after the multiplier effect takes place. For simplicity, assume that there is no…
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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 multiplier effect takes place. For simplicity, assume that there is no "crowding out." 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. 140 AD, 135 AD, 130 125 120 115 110 105 100 3 4 OUTPUT (Trillions of dollars) PRICE LEVEL
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