Consider two economies,A and B.Economy A has a marginal propensity to consume of 0.9,a net tax rate of 0.2 and a marginal propensity to import of 0.2.Economy B has a marginal propensity to consume of 0.7,a net tax rate of 0.2 and a marginal propensity to import of 0.2.Suppose there is an increase in autonomous investment of $5 billion in each of these economies.Which of the following statements is true?
A)The simple multiplier is larger in Economy A.
B)The AD curve shifts farther to the left in Economy B than Economy A.
C)The AD curve shifts farther to the right in Economy A than Economy B.
D)The AD curve shifts to the left the same amount in both economies.
E)The AD curve shifts to the right the same amount in both economies.

Question

Quizplus · Accepted Answer

To calculate the change in output for each economy, we can use the formula:

Change in output = (Multipliers) x Change in autonomous spending

The multiplier for each economy can be calculated as:

Multiplier = 1 / (1 - MPC + MPM(1 - tax rate))

For Economy A,

Multiplier = 1 / (1 - 0.9 + 0.2(1 - 0.2)) = 1 / 0.84 = 1.19

Change in output = 1.19 x $5 billion = $5.95 billion

For Economy B,

Multiplier = 1 / (1 - 0.7 + 0.2(1 - 0.2)) = 1 / 0.76 = 1.32

Change in output = 1.32 x $5 billion = $6.6 billion

Therefore, both economies will experience an increase in output, but Economy B will experience a larger increase in output, indicating that the AD curve shifts farther to the right in Economy A than in Economy B.

Consider Two Economies,A and B