Question

Suppose that the MPC = 0.60; there is no investment accelerator and no crowding-out. If government expenditures increase by $25 billion, how does aggregate demand change in direction and size as well?

If NX falls $40 billion, the MPC is 8/11, and there is a multiplier effect with no crowding out and no investment accelerator, how much does aggregate change direction and size as well? is 8/11 x 40 billion right?

Answer 1

1) MPC = 0.6

Spending Multiplier = [1 / (1 - MPC)] = [1 / (1 - 0.6)] = 2.5

Rise in government spending by $25 billion will raise aggregate demand because government spending and aggregate demand have positive relationship with each other.

Aggregate demand will rise by: Spending Multiplier * Rise in government spending = 2.5 * $25 billion = $62.5 billion

2) NX falls by $40 billion

MPC = 8/11 = 0.727

Spending Multiplier = [1 / (1 - 0.727)] = 3.66

Decrease in NX will reduce aggregate demand by $40 billion * 3.66 = -$146.66 billion