Question

If the MPC is 0.8 and there are no crowding-out or accelerator effects, then an initial increase in aggregate demand of $120 billion will eventually shift the aggregate demand curve to the right by:a. $480 billion.

b. $216 billion.
c. $600 billion.
d. $150 billion.

Answer 1

a. $480 billion.

Step-by-step explanation:

We can compute this by working out the multiplier.

Multiplier = 1 / MPS where,

MPS = Marginal propensity to save = 1 - Marginal propensity to consume.

MPS = 1 - 0.8 = 0.2

Multiplier = 1 /0.2 = 5

So change in aggregate demand of $120 billion will have a net effect of,

Net effect = 120 * 5 = $600 billion.

This is the total aggregate demand increase.

The curve will second shift by = 600 - 120 = $480 billion.

Hope that helps.