If the consumption function is C = 200 + 0.75Y and there is a $10 million increase in consumption spending, then the aggregate demand curve will shift horizontally to the right by:
A) $750 million.
B) $7.5 million.
C) $75 million.
D) $40 million.

Question

Quizplus · Accepted Answer

To calculate the shift in the aggregate demand curve, we need to divide the increase in consumption spending ($10 million) by the marginal propensity to consume (0.75):

$10 million / 0.75 = $13.33 million

Therefore, the aggregate demand curve will shift rightward by $13.33 million. However, the question asks for a horizontal shift, which means we need to consider the initial level of aggregate demand.

At Y = $0, consumption is C = $200. That means initial aggregate demand is:

AD = C + I + G + (X-M) = $200 + I + G + (X-M)

If consumption increases by $10 million, then at Y = $0, aggregate demand increases by:

ΔAD = $10 million + ΔI + ΔG + Δ(X-M)

We assume no change in investment, government spending, or net exports, so:

ΔAD = $10 million

To calculate the horizontal shift, we need to find the level of output where the initial and new aggregate demand curves intersect.

At the initial level of output (Y), aggregate demand is:

AD = $200 + 0.75Y

At the new level of output (Y'), aggregate demand is:

AD' = $210 million + 0.75Y'

We set these two expressions equal to each other and solve for Y':

$200 + 0.75Y = $210 million + 0.75Y'

0.75Y' = 0.75Y + $10 million

Y' = Y + $13.33 million

Therefore, the horizontal shift is $13.33 million, or approximately $40 million (assuming Y is in billions of dollars).

If the Consumption Function Is C = 200 + 0