4. The multiplier effect of a change in government purchases

Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30.

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 toincreasegovernment purchases by $300 billion. The increase in government purchases will lead to an increase in income, generating an initial change in consumption equal to . This increases income yet again, causing 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 (AD

1

AD1) for this economy before the change in government spending.

Use the green line (triangle symbol) to plot the new aggregate demand curve (AD

2

AD2) 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

2

AD2) is parallel to the initial aggregate demand curve (AD

1

AD1). You can see the slope ofAD

1

AD1by selecting it on the graph.?

C Date: 30/11/2019 A... YouTube PERSONAL BANKIN... ps Sign in to your acco. CENGAGE MINDTAP Homework (Ch 34) 140 AD 135 AD 2 130 125 120 PRICE LEVEL 115 110 105 100 0 6 8 OUTPUT (Trillions of dollars) Type here to search m