5. Fiscal policy, the money market, and aggregate demand

Suppose there is some hypothetical economy in which households spend $0.50 of each additional dollar they earn and save the $0.50 they have left over. The following graph plots the economy's initial aggregate demand curve (AD1).

Suppose now that the government increases its purchases by $2.5 billion.

Use the green line (triangle symbol) on the following graph to show the aggregate demand curve (AD2) after the multiplier effect takes place.

Hint: Be sure the new aggregate demand curve (AD2) is parallel to AD1. You can see the slope of AD1by selecting it on the following graph.

\f12 Money Supply O 10 Money Demand Money Supply INTEREST RATE 4 Money Demand 2 20 40 60 80 100 120 MONEY (Billions of dollars)