Question

Scenario 34-2. The following facts apply to a small economy. • Consumption spending is $6,720 when income is $8,000. • Consumption spending is $7,040 when income is $8,500. Refer to Scenario 34-2. In response to which of the following events could aggregate demand increase by $1,500? A stock market boom stimulags consumer spending by $550, and there is a small operative crowding-out effect. A stock market boom stimulates consumer spending by $300, and there is an operative crowding-out effect An economic boom overseas increases the demand for U.S. net exports by $550, and there is no crowding-out effect. An economic boom overseas increases the demand for U.S. net exports by $300, and there is no crowding-out effect.

Answer 1

Answer is D.

An increase in income by $300 will increase the aggregate demand by $1500 if there is no crowding out effect.

Here MPC = 7040/8500 = 0.82

So multiplier = 1/1-MPC = 1/1-0.82 = 1/0.18 = 5.55

So total increase in expenditure = Value of multiplier * initial change in income = 5.5* 300 = 1650.

So approximately total expenditure will increase by $1500 when there is increase in income or net exports by $300.

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