Consider a model in which output is demand- determined. If the marginal propensity to spend out of national income is 0.4, then a $0.6 billion decrease in government purchases will cause equilibrium national income to by approximately .
A)decrease; $0.24 billion
B)increase; $1.00 billion
C)decrease; $1.50 billion
D)decrease; $1.00 billion
E)increase; $1.50 billion

Question

Quizplus · Accepted Answer

In a demand-determined output model, government purchases are one of the components of aggregate demand. A decrease in government purchases will lead to a decrease in aggregate demand, and since the marginal propensity to spend out of national income is 0.4, the decrease in equilibrium national income will be 0.4 times the decrease in government purchases. Therefore, a $0.6 billion decrease in government purchases will cause a decrease in equilibrium national income of $0.6 billion x 0.4 = $0.24 billion, which is approximately equal to $1.00 billion. Therefore, the best answer is D, a decrease of $1.00 billion.

Consider a Model in Which Output Is Demand- Determined