Suppose there are three economies with 3 different consumption functions: Country A: C = 100 + 0.8Y Country B: C = 200 + 0.75 Y
Country C: C = 75 + 0.9Y
If the government spending increases by 10, in which of these countries would the shift of the AD curve be the largest?
A) Country B
B) Country C
C) Country A
D) All countries have the same shifts in the aggregate demand.

Question

Quizplus · Accepted Answer

We can use the formula AD = C + I + G to find the AD curve after the increase in government spending. Assuming investment and net exports remain constant, the change in AD will depend on the change in consumption (C).

For Country A: AD = 100 + 0.8Y + I + G. The change in AD will be 0.8 times the increase in G, which is 8.

For Country B: AD = 200 + 0.75Y + I + G. The change in AD will be 0.75 times the increase in G, which is 7.5.

For Country C: AD = 75 + 0.9Y + I + G. The change in AD will be 0.9 times the increase in G, which is 9.

Therefore, Country C will have the largest shift in the AD curve.

Suppose There Are Three Economies with 3 Different Consumption Functions