Question

For the following problems, use the information provided to determine which direction the AD will shift and by how much the AD curve will shift. 7. Assume the MPC is 0.75. Assuming only the multiplier effect matters, a decrease in government purchases of $100 billion will shift the aggregate demand curve to the 8. Assume the multiplier is 5 and that the crowding-out effect is $20 billion. An increase in government purchases of $10 billion will shift the aggregate-demand curve to the 9. Assume the MPC is 0.625. Assuming only the multiplier effect matters, a decrease in government purchases of $10 billion will shift the aggregate demand curve to the

Answer 1

Use the fact that spending multiplier is 1/(1-MPC) and change in government expenditure X spending multiplier = change in aggregate demand

7) marginal propensity to consume is 0.75 which means that spending multiplier is 1 / 0.25 = 4. Government expenditure is decreased by 100 billion. Aggregate demand will be shifted to the left by 100 x 4 = 400 billion

8) spending multiplier = 5. Government expenditure is increased by 10 billion. Aggregate demand will be shifted to the right by 100 x 4 = 400 billion. Because there is a crowding out effect of 20 billion, the size of the shift will be decreased by 20 billion. Therefore finally the aggregate demand curve will be shifting to the right by 380 billion

9) marginal propensity to consume is 0.625 which means that is spending multiplier is 1 / 0.375 = 2.67 . Government expenditure is decreased by 10 billion. Aggregate demand will be shifted to the left by 10 x 2.67 = 26.67 billion