Scenario 34-1. Take the following information as given for a small economy:
• When income is $10,000, consumption spending is $6,500.
• When income is $11,000, consumption spending is $7,250.
-Refer to Scenario 34-1. For this economy, an initial increase of $200 in net exports translates into a(n)
A)$570 increase in aggregate demand when the crowding-out effect is taken into account.
B)$800 increase in aggregate demand when the crowding-out effect is taken into account.
C)$1,400 increase in aggregate demand in the absence of the crowding-out effect.
D)$800 increase in aggregate demand in the absence of the crowding-out effect.

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) is calculated as the change in consumption divided by the change in income, which is ($7,250 - $6,500) / ($11,000 - $10,000) = 0.75. The multiplier effect is 1 / (1 - MPC) = 1 / (1 - 0.75) = 4. Therefore, an initial increase of $200 in net exports would result in an $800 increase in aggregate demand (200 * 4) in the absence of the crowding-out effect.