Question

1. Now assume that we have an MPC of .8 and the economy in # 1 faces a sudden investment expenditure increase of $100.  If the initial equilibrium is at a real GDP level of $2000 then what will the new equilibrium be? How much will the equilibrium level of output and expenditure change?  Show the diagram for this scenario.   

Answer 1

Ans. Aggregate Expenditure, AE = Consumption + Investment + Government Expenditure + Net Exports

Increase In AE due to $100 increase in investment, keeping everything else constant will increases the aggregate expenditure by $100. Thus, aggregate expenditure curve shifts upward from AE to AE' .

Increaese in real GDP = multiplier * Increase in investment expenditure

Here, Multiplier = 1/(1-MPC) = 1/(1-0.8) = 5

=> Increase in real GDP = 5*100 = $500

Thus, real GDP increases by $500 to $2500

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