Scenario 21-1. Take the following information as given for a small, imaginary economy:
- When income is $\$ 10,000$, consingtion spending is $\$ 6,500$
- Whan income is $\$ 11,000$, cansumption spending is $\$ 7,300$
-Refer to Scenario 21-1. For this economy, an initial increase of $500 in net exports translates into a
A)$2,000 increase in aggregate demand when the crowding-out effect is taken into account.
B)$2,500 increase in aggregate demand when the crowding-out effect is taken into account.
C)$2,000 increase in aggregate demand in the absence of the crowding-out effect.
D)$2,500 increase in aggregate demand in the absence of the crowding-out effect.

Question

Scenario 21-1. Take the following information as given for a small, imaginary economy:
 - When income is $\$ 10,000$, consingtion spending is $\$ 6,500$
- Whan income is $\$ 11,000$, cansumption spending is $\$ 7,300$
-Refer to Scenario 21-1. For this economy, an initial increase of $500 in net exports translates into a
A)$2,000 increase in aggregate demand when the crowding-out effect is taken into account.
B)$2,500 increase in aggregate demand when the crowding-out effect is taken into account.
C)$2,000 increase in aggregate demand in the absence of the crowding-out effect.
D)$2,500 increase in aggregate demand in the absence of the crowding-out effect.

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is calculated as the change in consumption divided by the change in income, which is $(7,300 - 6,500) / (11,000 - 10,000) = 0.8$. The multiplier is $1 / (1 - MPC) = 1 / (1 - 0.8) = 5$. Therefore, a $500 increase in net exports would increase aggregate demand by $500 \times 5 = 2,500$ in the absence of the crowding-out effect.

Scenario 21-1 $10,000\$ 10,000$10,000 , Consingtion Spending Is $6,500\$ 6,500$6,500 - Whan Income Is

Scenario 21-1 $\$ 10,000$ , Consingtion Spending Is $\$ 6,500$ - Whan Income Is