Assume that the MPC is 0.75.Assuming that only the multiplier effect matters,a decrease in government purchases of $10 billion will shift the aggregate demand curve
A)left by $13.5 billion.
B)left by $40 billion.
C)right by $75 billion.
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The multiplier effect refers to the fact that a change in autonomous expenditure (in this case, government purchases) leads to a larger change in equilibrium output. The formula for the multiplier effect is 1/(1-MPC), where MPC is the marginal propensity to consume. In this case, the multiplier effect is 1/(1-0.75) = 4. With a decrease in government purchases of $10 billion, the aggregate demand curve will shift by -10 x 4 = -40 billion, meaning that the curve will shift to the left by $40 billion. Therefore, option B is the correct choice.

Assume That the MPC Is 0