If investment spending decreases by $500 billion and if MPC = 0.6,
A) equilibrium GDP will rise by $1,250 billion
B) equilibrium GDP will fall by $500 billion
C) equilibrium GDP will fall by $1,250 billion
D) equilibrium GDP will rise by $500 billion
E) nothing will happen in the short run

Question

Quizplus · Accepted Answer

The decrease in investment spending of $500 billion will shift the aggregate expenditure (AE) curve downwards by $500 billion. With an MPC of 0.6, the change in equilibrium GDP can be found by multiplying the change in AE by the multiplier. The multiplier can be calculated as:
Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.6) = 2.5 
Therefore, the decrease in AE of $500 billion will result in an overall decrease in GDP of $1,250 billion (500 x 2.5).

If Investment Spending Decreases by $500 Billion and If MPC