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
icon
Related questions
Question

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
?
Transcribed Image Text: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 ?
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 2 steps with 1 images

Blurred answer
Knowledge Booster
Government Spending
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
Economics
ISBN:
9780190931919
Author:
NEWNAN
Publisher:
Oxford University Press
Principles of Economics (12th Edition)
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education