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Assume that the MPC is .8 in an economy that has an aggregate supply curve with...

Assume that the MPC is .8 in an economy that has an aggregate supply curve with a slope of 1. Also, suppose that the price level is flexible downward. A decrease in investment spending of $10 billion will shift the aggregate demand curve leftward by: (Show Steps)

A. $50 billion and decrease real GDP by $50 billion.
B. $50 billion and decrease real GDP by $25 billion.100%
C. $10 billion and decrease real GDP by $10 billion.   
D. $10 billion and decrease real GDP by $25 billion.   

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Answer #1

A) Right answer B) It won't be true since the fall in Gdp is not 25 $ c ) False , because it didn't take multiplier effect into consideration .d) False , due to the same reason as c Explanation According to Keynesian economics , a change in investment will lead to multiplier effects in the society . The value of multiplier is defined by k = 1/ 1- mpc or 1/ mps. Here the value of mpc is given as .8 so multiplier =1/1-.8 = 1/.2 = 5 // This implies that a 10$ reduction in aggregate investment in the economy will lead to a 5times ( 10×5) 50$ fall in aggregate demand. ii ) multiplier = change in real GDP / change in injections , ie 5 = change in real GDP/ 10 $ ,. so change in real GDP = 10$ ×5 = 50$

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