(Advanced analysis) Assume that the MPC is 0.8 in an economy that has an aggregate supply curve with a slope of 1.Also, suppose that the price level is flexible downward.A decrease in investment spending of $10 billion will shift the aggregate demand curve leftward by
A)$50 billion and decrease real GDP by $50 billion.
B)$50 billion and decrease real GDP by $25 billion.
C)$10 billion and decrease real GDP by $10 billion.
D)$10 billion and decrease real GDP by $25 billion.

Question

Quizplus · Accepted Answer

The multiplier is 1/(1-MPC) = 1/(1-0.8) = 5. So, a decrease in investment spending of $10 billion will shift the aggregate demand curve leftward by $10 billion * 5 = $50 billion. The decrease in real GDP will be $50 billion * (1/slope of AS) = $50 billion * (1/1) = $50 billion.

(Advanced Analysis) Assume That the MPC Is 0