Question

In each of the following cases, a particular fiscal policy affects an economy’s AD curve via the spending multiplier. Find the direction and size of the shift in the AD curve

Government purchases increase by $6 in an economy with MPW=0.5. Aggregate demand will ____ by ___? (Answer is 12, how did they get that?)

Government purchases decrease by $3 with an economy with MPC=0.55. Aggregate demand will ____ by ___? (Answer is 6.667, how did they get that?)

A $3 tax hike occurs in an economy with an MPW=0.5. Aggregate demand will ____ by ____? (Answer is 3, how did they get that?)

A $3 tax hike occurs in an economy with an MPC=0.55. Aggregate demand will ___ by____? (Answer is 3.667, how did they get that?)

A $5 tax cut causes an initial $1 increase in the aggregate demand. Aggregate demand will ___ by __? (Answer is 1.25, how did they get that?)

Answer 1

Q-1 :: ANSWER :: Shift Rightward,  By $12

=> Explanation ::

Multiplier = 1/MPW

= 1/0.5

=2

So AD Increase = $6 * 2 = $12

Q-2 :: ANSWER :: Shift Leftward, By $6.667

=> Explanation ::

Multiplier = 1/1-MPC

= 1/1-0.55

= 1/0.45

= 2.222

So AD Decrease By = $3 * 2.222

= 6.667

Q-3 :: ANSWER :: Shift Leftward, $3

=> Explanation ::

Multiplier = 1/MPW

= 1/0.5

= 2

So AD Decease By = $3 * 2

= $6 - $3

= 3

Q-3 :: ANSWER :: Shift Leftward, $3.667

=> Explanation ::

Multiplier = 1/MPW

= 1/0.5

= 2

So AD Decease By = $3 * 2

= $6 - $3

= 3

Q-4 :: ANSWER :: Shift Rightward, 1.25

=> Explanation ::

Multiplier = 1/1-MPC

So Here MPW is Not Given so MPC

= $1/$5

= 0.2

So Multiplier = 1/1-0.2

= 1/0.8

= 1.25