Assume the MPC is 0.80. Assume there is a multiplier effect and that the total crowding-out effect is $7 billion. An increase in government purchases of $40 billion will shift aggregate demand to the
A)left by $165 billion.
B)left by $193 billion.
C)right by $193 billion.
D)right by $165 billion.

Question

Quizplus · Accepted Answer

The multiplier effect is 1/(1-MPC) = 1/(1-0.80) = 5. So the increase in government purchases of $40 billion will increase aggregate demand by $40 billion x 5 = $200 billion. However, the crowding-out effect is $7 billion, so the net increase in aggregate demand is $200 billion - $7 billion = $193 billion.

Assume the MPC Is 0