Now, confirm your graphical analysis algebraically using the formula for the sim
ID: 1204921 • Letter: N
Question
Now, confirm your graphical analysis algebraically using the formula for the simple spending multiplier:
Simple Spending Multiplier = 1 / 1 - MPC
For the first economy with an MPC of 0.5, the effect of the $40 billion increase in investment becomes the following:
Change In Aggregate Output Demanded = Change in Aggregate Expenditure x Simple Spending Multiplier
= +$40 billion x 1 / 1 - _____
= +$40 billion x 1/ ______
= +$40 billion x ______
= __________
Using the same method, the simple spending multipllier for the second economy is ___________.
Consider two closed economies that are identical except for their marginal propensity to consume (MPC). Each economy is currently in equilibrium with real GDP and aggregate expenditure equal to $100billion, as shown by the black Xs on the following two graphs. Neither economy has taxes that change with income. The grey lines show the 45-degree line on each graph The first economy's MPC is 0.5. Therefore, its initial aggregate expenditure line has a slope of 0.5 and passes through the point (100, 100) AGGREGATE EXPENDITURE (Billions of dollars) 200 180 160 140 120 100 80 60 40 20 New AE Line New Agg. Output De AE Line Degree Line 0 20 40 60 80 100 120 140 160 180 200 REAL GDP (Billions of dollars] Help Clear Al The second economy's MPC is 0.6. Therefore, its initial aggregate expenditure line has a slope of 0.6 and passes through the point (100, 100)
Explanation / Answer
in the first graph with MPC=0.5, when investment increases by 40, the expenditure line shifts up by 40 intersecting the 45degree line at 180. it could be verified that multiplier=1/1-MPC=1/0.5=2. gdp increases by 40*2=80
in the 2nd economy MPC=0.6, when investment increases the expenditure line shfts up by vertical distance of 40, intersecting the 45degree line at 200. multiplier=1/1-MPC= 1/1-0.6= 2.5.
so gdp increases by 40*2.5=100
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