Consider a 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
Consider a 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
Chapter11: Fiscal Policy
Section: Chapter Questions
Problem 1.4P
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Transcribed Image Text:Consider a 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
and the spending multiplier for this economy is
Suppose the government in this economy decides to increase government purchases by $250 billion. The increase in government purchases will lead
to an increase in income, generating an initial change in consumption equal to
▼. This increases 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 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.
Friday,
140 T
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Transcribed Image Text: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
AD2
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1:09 PM
4/29/2022
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