Suppose the MPC in the economy in Figure 10.2 equals 0.75 and the shift from AD₀ to AD₁ was caused by a decrease in investment of $50 billion.What will happen to the equilibrium level of real output as a result of the initial $50 billion decrease? A)It will fall by less than $200 billion. B)It will fall by exactly $200 billion. C)It will fall by more than $200 billion. D)It will fall by less than $67 billion.

Question

Quizplus · Accepted Answer

The multiplier in this economy is 1/(1-MPC) = 1/(1-0.75) = 4. Therefore, the initial decrease in investment of $50 billion will lead to a decrease in real output of 4 times that amount, or $200 billion. However, since the MPC is not 1 (meaning that some of the income lost from the decrease in investment will be offset by an increase in consumption spending), the actual decrease in real output will be less than $200 billion. Specifically, it will be 0.75 times $200 billion, or $150 billion. Therefore, the equilibrium level of real output will fall by less than $200 billion.

Suppose the MPC in the Economy in Figure 10