7. Paradox of thrift Consider a hypothetical closed economy in which there are no income taxes. If households spend $0.75 of each additional dollar they earn and save the remainder, the expenditure multiplier for this economy is |:]. The following graph shows the initial aggregate demand (AD) and short-run aggregate supply (SRAS) curves of this economy. Suppose that the economy is currently in a recession. Business firms are pessimistic about the future and do not respond to a fall in interest rates. In addition, all households are pessimistic about job prospects and desire to consume less and save more at all levels of income. As a result, personal consumption in this economy decreases by $1 billion. The reduction in personal consumption will lead to a decrease in aggregate demand by [:J billion. Shift either the AD curve or the SRAS curve, or both, to show the new aggregate demand curve after the full impact of the multiplier process of the reduction in personal consumption has taken place, 100 -- 90 SRAS AD m 100 O 90 SRAS AD 80 70 SRAS 60 50 PRICE LEVEL (Billions of dollars) 40 30 AD 20 3 4 5 6 8 9 10 REAL GDP (Index numbers) Since an economy's aggregate output measured by real GDP also represents the aggregate income received by the resources of production within the economy, the decrease in aggregate demand you found equals the decrease in aggregate income. The effect of this decline in aggregate income is in total saving of |$ billion . As personal consumption falls by $1 billion, the economy reaches a new equilibrium with an aggregate output of |$ billion in the short run. The total amount of saving True or False: This is an example of the paradox of thrift. O False O True