Question

Suppose the MPC is .9. There are no crowding out or investment accelerator effects. If the government increases its expenditures by 30 billion, by how much does aggregate demand shift to the right? (Assuming the previous scenario still applies)

Answer 1

The government spending increase of $30 billion will shift aggregate demand to the right by $300 billion due to the multiplier effect.

Step-by-step explanation:

The multiplier effect is a concept in Keynesian economics that explains how an initial increase in government spending can have a larger impact on the economy. In this scenario, the marginal propensity to consume (MPC) is given as 0.9, which means that 90% of any increase in income is spent. To calculate the shift in aggregate demand, we can use the formula:

Change in Aggregate Demand = Change in Government Spending * Multiplier

Here, the change in government spending is $30 billion. The multiplier can be calculated using the formula:

Multiplier = 1 / (1 - MPC)

Plugging in the given MPC value of 0.9:

Multiplier = 1 / (1 - 0.9) = 1 / 0.1 = 10

Therefore, the change in aggregate demand is:

Change in Aggregate Demand = $30 billion * 10 = $300 billion