Question

Assume that the MPS is .33 in an economy that has an aggregate supply curve with a slope of 1. An increase in investment spending of $10 billion will shift the aggregate demand curve rightward by: (Show Steps)

A) $30 billion and increase real GDP by $15 billion.
B) $30 billion and increase real GDP by $30 billion.
C) $10 billion and increase real GDP by $30 billion.
D) $10 billion and increase real GDP by $10 billion.

Answer 1

Ans :- B

Explanation - in an economy when investment is increased, a forward multiplier effect operates, as a result income (GDP) increases many times more.

Multiplier (k) = delta Y/delta I =1/mps

Or delta Y/delta I = 1/mps

Or delta Y/10=1/0.33 or delta Y=10/0.33 =30 (approx).

So increase in real GDP =30 billion (approx) if economy is in underemployment.

At new equilibrium ;

Increase in AD =increase in real GDP

( because AS is at 45^° i. e. Slope of AS =1)

SO Aggregate demand and real GDP both increase by 30 billion.