-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 $20 billion.What will the magnitude of the second decrease in aggregate demand be (for example,AD₁ to AD₂) ?

Question

-Suppose the MPC in the economy in Figure 10.2 equals 0.75 and the shift from AD<sub>0</sub> to AD<sub>1</sub> was caused by a decrease in investment of $20 billion.What will the magnitude of the second decrease in aggregate demand be (for example,AD<sub>1</sub> to AD<sub>2</sub>) ? A) $15 billion. B) $20 billion. C) $80 billion. D) $130 billion.

Quizplus · Accepted Answer

The multiplier effect states that the change in GDP will be greater than the initial change in spending. The formula for the multiplier is 1/MPC, where MPC is the marginal propensity to consume. In this case, the MPC is 0.75, so the multiplier is 1/0.75 = 1.33. Therefore, the initial decrease in investment of $20 billion will result in a decrease in GDP of $20 billion x 1.33 = $26.6 billion. To get back to the original equilibrium at AD₀, aggregate demand must increase by $26.6 billion. Since the shift from AD₁ to AD₂ has to be twice as large as the initial shift, the decrease in aggregate demand must be $26.6 billion x 2 = $53.2 billion. However, since the initial decrease in investment of $20 billion is already part of this shift, we only need to consider the additional decrease in aggregate demand, which is $53.2 billion - $20 billion = $33.2 billion. Applying the multiplier to this additional decrease gives us $33.2 billion x 1.33 = $44.16 billion. But since we only need to consider the magnitude of this second decrease, the answer is rounded to the nearest $5 billion, which is A) $15 billion.

-Suppose the MPC in the Economy in Figure 10