Consider a hypothetical economy in which households spend $0.75 of each additional dollar they earn and save the remaining $0.25. The following graph shows the economy’s initial aggregate-demand curve ().
Suppose the government increases its purchases by $3.75 billion.
Use the green line (triangle symbol) on the following graph to show the aggregate-demand curve () after the multiplier effect takes place.
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Hint: Be sure the new aggregate-demand curve () is parallel to . You can see the slope of by selecting it on the following graph.
AD2AD3100105110115120125130135140116114112110108106104102100PRICE LEVELOUTPUT (Billions of dollars)AD1
The following graph shows the money market in equilibrium at an interest rate of 7.5% and a quantity of money equal to $60 billion.
Show the impact of the increase in government purchases on the interest rate by shifting one or both of the curves on the following graph.
Money DemandMoney Supply02040608010012015.012.510.07.55.02.50INTEREST RATEMONEY (Billions of dollars)Money Demand Money Supply
Suppose that for each one-percentage-point increase in the interest rate, the level of investment spending declines by $0.5 billion. The change in the interest rate (according to the change you made to the money market in the previous scenario) therefore causes the level of investment spending to (fall/rise) by .(2.5 billions/ 1.25 bil/ 0.62 bil)
After the multiplier effect is accounted for, the change in investment spending will cause the quantity of output demanded to (decrease/increase) by (5 bil/1.2 bil/2bil)at each price level. The impact of an increase in government purchases on the interest rate and the level of investment spending is known as the ( multiplier/liquidty preference/ automatic stabilizer/ crowding out) effect.
Use the purple line (diamond symbol) on the graph at the beginning of this problem to show the aggregate-demand curve () after accounting for the impact of the increase in government purchases on the interest rate and the level of investment spending.
Hint: Be sure your final aggregate-demand curve () is parallel to and . You can see the slopes of and by selecting them on the graph.