Suppose that planned investment increases by $200 billion and that the marginal propensity to consume equals 0.80.The aggregate expenditure line will shift upward by __________ at every level of real GDP.
A)$40 billion
B)$160 billion
C)$200 billion
D)$250 billion
E)$1,000 billion

Question

Quizplus · Accepted Answer

Planned investment is an injection into the economy, which will increase the aggregate expenditure by the same amount of $200 billion. The marginal propensity to consume of 0.80 means that for every additional dollar of income, people will spend $0.80, leading to a multiplier effect on the aggregate expenditure of 1/(1-MPC) = 1/(1-0.80) = 5. Therefore, the aggregate expenditure line will shift upward by 5 times the increase in planned investment, which is $200 billion multiplied by 5 = $1,000 billion. However, the question asks for the shift in aggregate expenditure per level of real GDP, so we need to divide $1,000 billion by the total output, which is unknown. Alternatively, we can calculate the shift in aggregate expenditure per unit of real GDP by using the multiplier times the increase in planned investment per unit of real GDP, which is 5 times $200 billion = $1,000 billion. Dividing $1,000 billion by the total output gives the fraction of the output that will be affected by the shift in aggregate expenditure, which is the slope of the aggregate expenditure line. Therefore, the answer is $200 billion, which represents the increase in expenditure per unit of real GDP at all levels of output.

Suppose That Planned Investment Increases by $200 Billion and That