Question

Assume the MPC is 0.625. Assuming only the multiplier effect matters, a decrease in government purchases of $10 billion will shift the aggregate demand curve to the a. left by about $13.3 billion. b. left by about $26.7 billion. c. right by about $36.7 billion. d. None of the above is correct.

Answer 1

Answer: b. left by about $26.7 billion.

Step-by-step explanation:

The multiplier determines how much government spending affects the aggregagte demand.

Multiplier is:

= 1 / ( 1 - MPC)

= 1 / (1 - 0.625)

= 2.67

The effect on Aggregate demand is:

= Government spending * Multiplier

= -10 billion * 2.67

= -$26.7 billion

Aggregate demand will shift left by $26.7 billion to show that aggregate demand is decreasing.