Assume that the MPC is 0.75.Assuming only the multiplier effect matters,an increase in government purchases of $200 billion will shift the aggregate demand curve
A)left by $150 billion.
B)left by $200 billion.
C)right by $800 billion.
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The multiplier effect tells us that a change in government purchases will lead to a larger change in aggregate demand. The size of the multiplier depends on the MPC. In this case, the MPC is 0.75, so the multiplier is 1 / (1 - MPC) = 1 / (1 - 0.75) = 4.

So, an increase in government purchases of $200 billion will lead to a change in aggregate demand of:

Change in AD = Multiplier x Change in G
Change in AD = 4 x $200 billion
Change in AD = $800 billion

Since the government purchases increased, the aggregate demand curve shifts to the right by $800 billion, choice C is correct.

Assume That the MPC Is 0