Scenario 24-2.The following facts apply to a small,imaginary economy.
• Consumption spending is $5,200 when income is $8,000.
• Consumption spending is $5,536 when income is $8,400.
-Refer to Scenario 24-2.For this economy,an initial increase of $500 in government purchases translates into a
A) $1,428.57 increase in aggregate demand in the absence of the crowding-out effect.
B) $3,125.00 increase in aggregate demand in the absence of the crowding-out effect.
C) $1,428.57 increase in aggregate demand when the crowding-out effect is taken into account.
D) $3,125.00 increase in aggregate demand when the crowding-out effect is taken into account.

Question

Quizplus · Accepted Answer

The marginal propensity to consume (MPC) can be calculated by dividing the change in consumption by the change in income. In this case, MPC = (5536-5200)/(8400-8000) = 0.236. Using the formula for the spending multiplier, 1/(1-MPC), we get a multiplier of 1.32. Therefore, an initial increase of $500 in government purchases will increase aggregate demand by $500 x 1.32 = $660. Hence, the correct answer is choice B.