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Chapter 21: Problem 4

Assume the economy is in recession and real GDP is below full employment. The marginal propensity to consume \((M P C)\) is \(0.80,\) and the government increases spending by \(\$ 500\) billion. As a result, aggregate demand will rise by a. zero. b. \(\$ 2,500\) billion. c. more than \(\$ 2,500\) billion. d. less than \(\$ 2,500\) billion.

Short Answer

Expert verified
The short answer is: The aggregate demand will rise by more than \(\$ 2,500\) billion.

Step by step solution

01

Identify the multiplier formula

The formula to calculate the multiplier is: \(Multiplier = \frac{1}{1-MPC}\)
02

Calculate the multiplier

Given the marginal propensity to consume (MPC) as 0.80, we can use the formula to calculate the multiplier: \(Multiplier = \frac{1}{1-0.80} = \frac{1}{0.20} = 5\)
03

Calculate the change in aggregate demand

Now that we have the multiplier, we can calculate the change in aggregate demand due to the increase in government spending. Change in Aggregate Demand = Multiplier × Change in Government Spending Change in Aggregate Demand = 5 × \(500\) billion.
04

Calculate the new amount of aggregate demand

Now, we can calculate the new amount of aggregate demand: New amount = 5 × \(500\) billion = \(2,500\) billion.
05

Determine the correct answer

Comparing our result with the given options, we find that the aggregate demand will rise by: c. more than \(\$ 2,500\) billion.

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Most popular questions from this chapter

If no fiscal policy changes are made, suppose the current aggregate demand curve will increase horizontally by \(\$ 1,000\) billion and cause inflation. If the marginal propensity to consume \((M P C)\) is \(0.80,\) federal policymakers could follow Keynesian economics and restrain inflation by decreasing a. government spending by \(\$ 200\) billion. b. taxes by \(\$ 100\) billion. c. taxes by \(\$ 1,000\) billion. d. government spending by \(\$ 1,000\) billion.

Mathematically, the value of the tax multiplier in terms of the marginal propensity to consume \((M P C)\) is given by the formula a. \(M P C-1\) b. \((M P C-1) / M P C\) c. \(1 / M P C\) d. \(1-[1 /(1-M P C)]\)

Which of the following is not an automatic stabilizer? a. Defense spending b. Unemployment compensation benefits c. Personal income taxes d. Welfare payments

Suppose inflation is a threat because the current aggregate demand curve will increase by \(\$ 600\) billion at any price level. If the marginal propensity to consume \((M P C)\) is \(0.75,\) federal policymakers could follow Keynesian economics and restrain inflation by a. decreasing taxes by \(\$ 600\) billion. b. decreasing transfer payments by \(\$ 200\) billion. c. increasing taxes by \(\$ 200\) billion. d. increasing government spending by \(\$ 150\) billion.

Assume the marginal propensity to consume \((M P C)\) is 0.75 and the government increases taxes by \(\$ 250\) billion. The aggregate demand curve will shift to the a. left by \(\$ 1,000\) billion. b. right by \(\$ 1,000\) billion. c. left by \(\$ 750\) billion. d. right by \(\$ 750\) billion.
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