7. 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 $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 AD1 by selecting it on the following graph. AD 2 AD 3 100 105 110 115 120 125 130 135 140 116 114 112 110 108 106 104 102 100 PRICE LEVEL OUTPUT (Billions of dollars) AD 1 The following graph plots equilibrium in the money market at an interest rate of 7.5% and a quantity of money equal to $45 billion. Show the impact of the increase in government purchases on the interest rate by shifting one or both of the curves on the following graph. Money Demand Money Supply 0 15 30 45 60 75 90