1. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) for this economy is 1 , and the spending multiplier for this economy is Suppose the government in this economy decides to decrease 0.2 ment purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in col 0.8 on equal to . This decreases income yet again, causing a second change in consumption equal to change in demand resulting from the initial change in government spending is 1 1.25 The following graph shows the aggregate demand curve (AD,) economy before the change in government spending. 5 Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the spending multiplier effect takes place. Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD,). You can see the slope of AD, by selecting it on the graph.