What effect would a $10 billion decrease in government purchases have on AD?
A)It would decrease AD by $4 billion if MPC = 0.4.
B)It would increase AD by $50 billion if MPC = 0.8.
C)It would increase AD by $20 billion if MPC = 0.5.
D)It would decrease AD by $30 billion if MPC = 2/3.

Question

Quizplus · Accepted Answer

The multiplier effect (1/MPS) indicates that a decrease in government purchases would cause a greater decrease in AD. The formula for the spending multiplier is 1/MPS, where MPS = 1 - MPC. Therefore, if MPC = 2/3 (meaning that consumers spend 2/3 of each additional dollar of income), the multiplier would be 1/ (1/3) = 3. This means that a $10 billion decrease in government purchases would cause a decrease in AD of 3 x $10 billion = $30 billion.

What Effect Would a $10 Billion Decrease in Government Purchases