Question

When Government Spending increases by $10 B Aggregate Demand increases by MORE than $10 B. Which...

When Government Spending increases by $10 B Aggregate Demand increases by MORE than $10 B. Which part of Aggregate Demand (C, I, G, or X?) increases so as to make this ripple effect, or multiplied impact, happen?

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Answer #1

C

Explanation:

An increase in government spending increases aggregate demand more than the amount by which government purchase was increased. This happens through multiplier effect.

Higher government purchase increases aggregate demand, which in turn increases income. Higher income increases consumption. Because, consumption is function of disposable income i.e. C=c(Y-T). This increased consumption further increases income. And again increased income increases consumption. In this way the multiplier effect continues and an increase in government purchase increases greater amount of income.

Hence, the answer is consumption or C.

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