Assume that the MPC is 0.75.Assume that there is a multiplier effect and that the total crowding-out effect is $6 billion.An increase in government purchases of $10 billion will shift aggregate demand
A)left by $24 billion.
B)left by $36 billion.
C)right by $34 billion.
D)right by $36 billion.

Question

Quizplus · Accepted Answer

The formula for the multiplier effect is:
Multiplier effect = 1/ (1 - MPC)
= 1/ (1 - 0.75) = 4

Therefore, an increase in government purchases of $10 billion would increase total spending by:
Multiplier effect x Increase in government purchases
= 4 x $10 billion
= $40 billion

However, there is also a crowding-out effect of $6 billion, which reduces the overall increase in spending.

Therefore, the net increase in aggregate demand would be:
$40 billion - $6 billion = $34 billion

Since an increase in government purchases leads to an increase in aggregate demand, the correct answer is (C) right by $34 billion.

Assume That the MPC Is 0