4. The multiplier effect of a change in government purchases Suppose there is some 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 *, and the spending multiplier for this economy is Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government spending will lead to a decrease in income, creating an initial change in consumption equal to . This decreases income yet again, leading to a second change in consumption equal to . The total change in demand resulting from the initial change in government spending is The following graph shows the aggregate demand curve (A.D,) for this economy before the change in government spending. Use the green line (triangle symbol) to plot the new aggregate demand curve (AD.) after the multiplier effect takes place. For simplicity, assume that there is no "crowding out." 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, by selecting it on the graph. 1-40 AD, 130 125 PRICE LEVEL 120 115 OUTPUT (Trillions of dollars)