Suppose planned investment increases by $200 billion and the marginal propensity to consume equals 0.80.By what amount will the aggregate expenditure line shift upward at every level of real GDP?
A) by $40 billion
B) by $160 billion
C) by $200 billion
D) by $250 billion

Question

Suppose planned investment increases by $200 billion and the marginal propensity to consume equals 0.80.By what amount will the aggregate expenditure line shift upward at every level of real GDP?  
A) by $40 billion 
B) by $160 billion 
C) by $200 billion 
D) by $250 billion

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is the fraction of any additional income that is spent. In this case, the MPC is 0.80, which means that for every additional dollar of income, people will spend 80 cents and save the remaining 20 cents. The increase in planned investment of $200 billion will increase income levels by the same amount. According to the multiplier effect, an increase in investment spending will result in a multiple increase in aggregate expenditure. The formula for the multiplier is 1/(1-MPC), so a multiplier of 5 is created (1/0.2). So, the total increase in aggregate expenditure will be $200 billion x 5 = $1 trillion. Therefore, the aggregate expenditure line will shift upward by $200 billion at every level of real GDP.

Suppose Planned Investment Increases by $200 Billion and the Marginal