4. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40. The marginal propensity to consume (MPC) for this economy is 0.6, and the spending multiplier for this economy is 2.5 Suppose the government in this economy decides to decrease government purchases by $400 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to This decreases income yet again, causing second change in consumption equal to The total change in from the initial change in government spendir -$1,000 billion -$120 billion In government spending. The following graph shows the aggregate demand curve (AD) for this economy bd -$160 billion -$500 billion lier effect takes place. For simplicity, assume Use the green line (triangle symbol) to plot the new aggregate demand curve (AD there is no "crowding out." -$240 billion Hint: Be sure that the new aggregate demand curve (AD) is parallel to the initial aggregate demand curve (AD). You can see the slope of AD selecting it on the graph