22. Assume the multiplier is 5 and that the total crowding-out effect is $20 bil
ID: 1116586 • Letter: 2
Question
22. Assume the multiplier is 5 and that the total crowding-out effect is $20 billion. An increase in government purchases of $10 billion when the multiplier is 5 will shift the aggregate demand curve a. right $150 billion. b. right S70 billion. c. right $30 billion. d. None of the above is correct. 23. An increase in government purchases is likely to a. decrease interest rates b. result in a net decrease in aggregate demand. c. crowd out investment spending by business. d. decrease money demand. Suppose the MPC is.60. Assume there are no crowding out or investment accelerator effects. If the government increases expenditures by $200 billion how far does aggregate demand shift? If the governmer decreases taxes by $200 billion how does aggregate demand shift? a. $300 billion and $180 billion b. $300 billion and $300 billion c. $500 billion and $300 billion d. $500 billion and $500 billion 24.Explanation / Answer
(22) (c).
Increase in government purchase will increase aggregate demand, shifting AD curve right.
When government purchases increase by $10 billion, without crowding out, increase in AD = $10 billion x 5 = $50 billion
Overall rightward shift of aggregate demand ($ billion) = 50 - Crowding out effect = 50 - 20 = 30
(23) (c)
Higher government purchase will increase budget deficit and government will increase borrowing to fund the deficit. This increases interest rate which will decrease investment demand.
(24) (c)
Spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.6) = 1 / 0.4 = 2.5
So, as government spending rises by $200 billion, aggregate demand rises by ($200 billion x 2.5) = $500 billion.
Tax multiplier = - MPC / (1 - MPC) = - 0.6 / 0.4 = - 1.5
So, as tax falls by $200 billion, aggregate demand rises by ($200 billion x 1.5) = $300 billion.
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