Suppose aggregate output is demand determined.If the marginal propensity to spend is 0.5,and the MPC is 0.7,a $1 billion reduction in government purchases will cause equilibrium national income to ________ by ________.
A)decrease; $3.33 billion
B)decrease; $2.00 billion
C)decrease; $1.50 billion
D)increase; $2.00 billion
E)increase; $3.33 billion

Question

Quizplus · Accepted Answer

With a demand-determined output, a $1 billion reduction in government purchases will cause a decrease in aggregate demand, which will ultimately result in a decrease in equilibrium national income. The MPC is relevant in determining the magnitude of this decrease. The MPC of 0.5 means that for every dollar decrease in income, consumption will decrease by 50 cents. The MPC of 0.7 means that for every dollar increase in income, consumption will increase by 70 cents. Therefore, the total decrease in equilibrium national income will be:

1 / (1 - MPC) = 1 / (1 - 0.7) = 3.33

So, a $1 billion reduction in government purchases will cause equilibrium national income to decrease by $2 billion (2 * 1 billion).

Suppose Aggregate Output Is Demand Determined