Suppose that government spending on defense rises by $50 billion. What happens to the aggregate demand curve if the multiplier is greater than 1?
A) It shifts right by $50 billion at each price level.
B) It shifts right by more than $50 billion at each price level.
C) It shifts right by less than $50 billion at each price level.
D) The aggregate demand does not shift; the aggregate supply curve shifts right by $50 billion at each price level.

Question

Quizplus · Accepted Answer

If the multiplier is greater than 1, then the initial increase in government spending of $50 billion will lead to a greater increase in aggregate demand. This is because the increase in government spending will lead to an increase in income, which in turn will lead to an increase in consumption spending. This increase in consumption spending will lead to further increases in income and consumption spending, which will lead to a greater increase in aggregate demand than the initial increase in government spending. Therefore, the aggregate demand curve will shift right by more than $50 billion at each price level.

Suppose That Government Spending on Defense Rises by $50 Billion