Assume that there is a $20 billion increase in government purchases.If MPC = 0.8, the sum of the indirect effect on aggregate demand through induced additional consumption purchases is equal to:

Question

Quizplus · Accepted Answer

The formula to calculate the total effect of a change in government purchases is:
Total effect = direct effect + indirect effect
Direct effect = Change in government purchases
Indirect effect = MPC x Change in government purchases
In this case, the change in government purchases is $20 billion. 
The indirect effect through induced consumption can be calculated as:
Indirect effect = MPC x change in government purchases
Indirect effect = 0.8 x $20 billion
Indirect effect = $16 billion
Therefore, the total effect on aggregate demand is:
Total effect = direct effect + indirect effect
Total effect = $20 billion + $16 billion
Total effect = $36 billion
However, the question asks only for the indirect effect through induced consumption, which is $16 billion. 
Therefore, the correct answer is C) $40 billion.

Assume That There Is a $20 Billion Increase in Government