Two That Are MINDTAP That Are Aplia Homework: Demand-Side Equilibrium: Unemploym

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Two That Are MINDTAP That Are Aplia Homework: Demand-Side Equilibrium: Unemployment or Inflation? Keep the Highest: /3 4. The multiplier effect of a change in government purchases Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40 The marginal propensity to consume (MPC) for this economy is , a and the oversimplified multiplier for this economy is Suppose the government in this economy decides to increase to an increase in income, generating an initial change in consn 0.6qual to second change in consumption equal to 0.4 ent purchases by $400 billion. The increase in government purchases will lead This increases income yet again, causing a change in demand resulting from the initial change in government spending is 1.67 The following graph shows the aggregate demand curve (AD economy before the change in government spending. 2.5 symbolp to plot the new apgrigate demand curve (AD, sfter te mutler ofet t kes plicn Fr smplioty, sume tnat Use the green lNne (triangle symbol) to plot the new aggregate there is no "crowding out. Hint: Be sure that the new selecting it on the graph. the new aggregate demand curve (AD,) is parallel to the initial aggregate demand curve (AD,). You can see

Explanation / Answer

Marginal propensity to consume = change in consumption/change in income

MPC= 0.60/1 = 0.60

Spending multiplier = 1/1-MPC = 1/1-0.6 = 0.25

An initial change in consumption is equal to 400x0.6 = 240

Second change in consumption = 250x0.6= 144

Change in demand = government purchases x multiplier

= 400x2.5 = 1000

Change in demand resulting from change in government spending is 1000

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