Question

According to the concept of the multiplier, if the marginal propensity to consume is 0.75 and a fall in the interest rate increases investment spending by $40, the aggregate demand curve will shift to the right by:

a) 10
b) 30
c) 160
d) 70

Answer 1

The multiplier effect explains how a change in government spending or investment can have a larger impact on aggregate demand and GDP. In this case, with an MPC of 0.75 and a $40 increase in investment spending, the aggregate demand curve will shift to the right by $160.

Step-by-step explanation:

The multiplier effect is the concept that explains how a change in government spending or investment can have a larger impact on aggregate demand and GDP. It is based on the Marginal Propensity to Consume (MPC), which represents the proportion of additional income that is spent rather than saved. The formula for the multiplier is 1 / (1 - MPC).

In this case, the MPC is given as 0.75. Therefore, the multiplier is 1 / (1 - 0.75) = 4.

Since investment spending has increased by $40, the impact on aggregate demand will be 4 times that amount, which is $40 * 4 = $160. Therefore, the correct answer is c) 160.