Consider a hypothetical economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The following graph shows the economy's initial aggregate demand curve ( AD1 ).

Suppose the government increases its purchases by $1 billion.

After the multiplier effect, the increase in government purchases will cause the quantity of output demanded to_______ by $ billion at each price level.

Place the green line (triangle symbol) on the following graph to show the aggregate demand curve ( AD2 ) after the multiplier effect takes place. Be sure the new aggregate demand curve ( AD2 ) is parallel to AD1 . Hover your mouse over the AD1 curve to see its slope. AD 2 AD 3 100 110 120 130 140 116 112 108 104 100 PRICE LEVEL QUANTITY OF OUTPUT (Billions of dollars) AD 1 The following graph shows the loanable funds market in equilibrium at an interest rate of 3%.

On the following graph, show the impact of the increase in government purchases on the interest rate by shifting one or both of the curves. Demand Supply 0 10 20 30 40 50 60 6 5 4 3 2 1 0 INTEREST RATE QUANTITY OF LOANABLE FUNDS (Billions of dollars) Demand Supply

Suppose that for each one-percentage-point increase in the interest rate, the level of investment spending declines by $3 billion.

According to the change you made to the loanable funds market in the previous scenario, the increase in government purchases causes the interest rate in the money market to_____(fall / rise) from 3% to %____ . The change in the interest rate causes the level of investment spending to by_____(fall / rise) $____ billion.

After the multiplier effect is accounted for, the change in investment spending will cause the quantity of output demanded to_______ (increase or decrease) by $______ billion at each price level. The impact of an increase in government purchases on the interest rate and the level of investment spending is known as the effect________.

Place the purple line (diamond symbol) on the graph at the beginning of this problem to show the aggregate demand curve AD3 after accounting for the impact of the increase in government purchases on the interest rate and the level of investment spending. Be sure your final aggregate demand curve ( AD3 ) is parallel to AD1 and AD2 . You can see the slopes of AD1 and AD2 by mousing over them on the graph.