Question

If investment increases by $10 billion and the economy's MPC is .8, the aggregate demand curve will shift:

A) leftward by $40 billion at each price level.
B) rightward by $10 billion at each price level.
C) rightward by $50 billion at each price level.
D) leftward by $20 billion at each price level.

Answer 1

The aggregate demand curve will shift rightward by $50 billion at each price level due to the multiplier effect of the investment increase combined with the economy's MPC of .8.

Step-by-step explanation:

If investment increases by $10 billion and the economy's marginal propensity to consume (MPC) is .8, the effect on the aggregate demand (AD) curve can be calculated using the spending multiplier formula, which is 1/(1-MPC). In this case, the multiplier would be 1/(1-0.8) = 5. Therefore, the initial $10 billion increase in investment would lead to a total increase in aggregate demand of 5 x $10 billion = $50 billion. Consequently, the aggregate demand curve will shift rightward by $50 billion at each price level, indicating option C) as the correct answer.