Consider two economies,A and B.Economy A has a marginal propensity to consume of 0.9,a net tax rate of 0.1 and a marginal propensity to import of 0.1.Economy B has a marginal propensity to consume of 0.6,a net tax rate of 0.2 and a marginal propensity to import of 0.2.Suppose there is a decrease in autonomous investment of $5 billion in each of these economies.Which of the following statements is true?
A)The AD curve shifts farther to the left in Economy A than Economy B.
B)The AD curve shifts farther to the right in Economy A than Economy B.
C)The AD curve shifts to the left the same amount in both economies.
D)The AD curve shifts to the right the same amount in both economies.
E)The simple multiplier is larger in Economy B.

Question

Quizplus · Accepted Answer

The multiplier effect in an economy is determined by the formula 1/(1 - MPC(1 - tax rate) + MPM), where MPC is the marginal propensity to consume, MPM is the marginal propensity to import, and the tax rate is the net tax rate. Economy A, with a higher MPC and lower tax and import rates, will have a larger multiplier effect than Economy B. Therefore, a decrease in autonomous investment will have a larger negative impact on aggregate demand (AD) in Economy A than in Economy B, causing the AD curve to shift farther to the left in Economy A.

Consider Two Economies,A and B