Question

Assuming that there is no government spending or trade, an economy’s aggregate

demand is given by its domestic consumption C and investment I:AD=C+I=c0 +c1Y+I

In the economy’s goods market equilibrium this equals its output: AD = Y. Solving for Y, this yields:

Y = [1/(1 - c1 )] (c0 + I)

Given this equation, which of the following statements is correct? Select one answer and provide explanations for each choice:

a) The multiplier is given by 1 – c1.

b) The boost in the economy’s output is the same, regardless of whether the aggregate demand shock comes from an increase in investment I or in autonomous consumptionc0.

c) The larger the marginal propensity to consume (c1), the smaller the multiplier.

d) If c1 = 1/3, then a £1 million increase in investment would result in a £2 million increase in output.

Answer 1

The boost in the economy’s output is the same, regardless of whether the aggregate demand shock comes from an increase in investment I or in autonomous consumption c0. Therefore, the correct option is B.

Step-by-step explanation:

The correct statement from the given options is:

b) The boost in the economy’s output is the same, regardless of whether the aggregate demand shock comes from an increase in investment I or in autonomous consumption c0.

This statement is correct because the equation Y = [1/(1 - c1)] (c0 + I) shows that the boost in output (Y) is determined by the combination of autonomous consumption (c0) and investment (I), regardless of which component increases.

For example, if c0 = 100 and I = 200, the equation gives Y = [1/(1 - c1)] (100 + 200) = [1/(1 - c1)] (300).