4. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30. The marginal propensity to consume (MPC) for this economy is ▼ , and the spending multiplier for this economy is Suppose the government in this economy decides decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to This decreases income yet again, causing a second change in consumption equal to The total change in demand resulting from the initial change in government spending is The following graph shows the aggregate demand curve (AD1) for this economy before the change in government spending. Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the multiplier effect takes place. For simplicity, assume that there is no "crowding out." Hint: Be sure that the new aggregate demand curve (AD2 ) is parallel to the initial aggregate demand curve (ADI ). You can see the slope of AD, by selecting it on the graph. 140 AD, A 135 AD, 130 125 120 115 110 105 100 1 3 4 5 6 7 8 OUTPUT (Trillions of dollars) PRICE LEVEL
4. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30. The marginal propensity to consume (MPC) for this economy is ▼ , and the spending multiplier for this economy is Suppose the government in this economy decides decrease government purchases by $300 billion. The decrease in government purchases will lead to a decrease in income, generating an initial change in consumption equal to This decreases income yet again, causing a second change in consumption equal to The total change in demand resulting from the initial change in government spending is The following graph shows the aggregate demand curve (AD1) for this economy before the change in government spending. Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the multiplier effect takes place. For simplicity, assume that there is no "crowding out." Hint: Be sure that the new aggregate demand curve (AD2 ) is parallel to the initial aggregate demand curve (ADI ). You can see the slope of AD, by selecting it on the graph. 140 AD, A 135 AD, 130 125 120 115 110 105 100 1 3 4 5 6 7 8 OUTPUT (Trillions of dollars) PRICE LEVEL
Chapter11: Fiscal Policy
Section: Chapter Questions
Problem 1.4P
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Transcribed Image Text:4. The multiplier effect of a change in government purchases
Consider a hypothetical closed economy in which households spend $0.70 of each additional dollar they earn and save the remaining $0.30.
The marginal propensity to consume (MPC) for this economy is
and the spending multiplier for this economy is
Suppose the government in this economy decides to decrease government purchases by $300 billion. The decrease in government purchases will
lead to a decrease in income, generating an initial change in consumption equal to
. This decreases income yet again, causing a
second change in consumption equal to
The total change in demand resulting from the initial change in government spending is
The following graph shows the aggregate demand curve (AD1) for this economy before the change in government spending.
Use the green line (triangle symbol) to plot the new aggregate demand curve (AD2) after the multiplier effect takes place. For simplicity, assume that
there is no "crowding out."
Hint: Be sure that the new aggregate demand curve (AD2) is parallel to the initial aggregate demand curve (AD1). You can see the slope of AD1 by
selecting it on the graph.
140
AD
135
AD2
130
125
120
115
110
105
100
2
3
4
5
6
7
8
OUTPUT (Trillions of dollars)
PRICE LEVEL
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