Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40. 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 $400 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 spending multiplier effect takes place. 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 (CPI) 140 135 130 125 120 115 110 REAL GDP 1 2 3 4 5 6 7 8 AD₁ AD₂ ?

Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40. 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 $400 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 spending multiplier effect takes place. 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 (CPI) 140 135 130 125 120 115 110 REAL GDP 1 2 3 4 5 6 7 8 AD₁ AD₂ ?

Exploring Economics

8th Edition

ISBN:9781544336329

Author:Robert L. Sexton

Publisher:Robert L. Sexton

Chapter24: Fiscal Policy

Section: Chapter Questions

Problem 5P

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