1. If the MPC is 0.60 and there are no crowding-out or accelerator (multiplier)
ID: 1126767 • Letter: 1
Question
1. If the MPC is 0.60 and there are no crowding-out or accelerator (multiplier) effects, then an initial increase in
aggregate demand of $200 billion will eventually shift the aggregate demand curve to the right by
a. $80 billion.
b. $125 billion.
c. $250 billion.
d. $500 billion.
2. If a $2,000 increase in income leads to a $1500 increase in consumption expenditures, then the marginal
propensity to consume is
a. 0.75 and the multiplier is 1 1/3.
b. 0.75 and the multiplier is 4.
c. 0.25 and the multiplier is 1 1/3.
d. 0.25 and the multiplier is 4.
3. To reduce the effects of crowding out caused by an increase in government expenditures, the Central Bank
could
a. increase the money supply by buying bonds.
b. increase the money supply by selling bonds.
c. decrease the money supply by buying bonds.
d. increase the money supply by selling bonds.
Explanation / Answer
Question 1
MPC = 0.60
Multiplier = 1/(1-MPC) = 1/(1-0.60) = 1/0.40 = 2.5
Eventual increase in aggregate demand = Initial increase in aggregate demand * Multiplier
Eventual increase in aggregate demand = $200 billion * 2.5 = $500 billion
The aggregate demand curve will eventually shift to the right by $500 billion.
The correct answer is the option (d).
Question 2
MPC = Increase in consumption/Increase in income
MPC = 1,500/2,000 = 0.75
Multiplier = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4
Thus, the MPC is 0.75 and Multiplier is 4.
The correct answer is the option (b).
Question 3
Increase in government expenditures leads to budget deficit which in turn leads to increase in demand for loanable funds by government leading to increase in interest rate which creates crowding out effect.
In such scenario, Central Bank could increase money supply by increasing money supply by buying bonds and thus square-off increase in interest rates and thereby reduce efects of crowding out.
The correct answer is the option (a).
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