The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.80 of each additional dollar they earn and save the remaining $0.20. The marginal propensity to consume (MPC) for this economy is (0.2, 0.8, 1, 1.25. or 5), and the spending multiplier for this economy is (0.2, 0.8, 1, 1.25. or 5) Suppose the government in this economy decides to increase government purchases by $400 billion. The increase in government purchases will lead to an increase in income, generating an initial change in consumption equal to ($ 80 Billion, $ 160 Billion, $ 320 Billion , 1000 Billion , or 2000 Billion). This increases income yet again, causing a second change in consumption equal to ($ 80 Billion, $ 160 Billion, $ 256 Billion , 1000 Billion , or 2000 Billion). . The total change in demand resulting from the initial change in government spending is ($ 800 Billion, $ 1600 Billion, $ 3200 Billion , or 2000 Billion). The following graph shows the aggregate demand curve (ADIADl) for this economy before the change in government spending. Use the green line (triangle symbol) to plot the new aggregate demand curve (ADZADZ) after the spending multiplier effect takes place. Hint: Be sure that the new aggregate demand curve (ADzADZ) is parallel to the initial aggregate demand curve {ADIAD1). You can seethe slope of ADIADI by selecting it on the graph. C?) 140 - AD1 A 135 - ADE 130 - E 125 - Q _l g m 120 - _I 8 E 115 - CL 110 -- 105 ' 100 -r l l l i l i U 1 2 3 4 5 6 T 3 REAL GDP (Trillions of dollars)