Question

If investment increases by $10 billion and the economy's MPC is .8, the aggregate demand curve will shift:A. rightward by$10 billion at each price level.
B. leftward by $40billion at each price level.
C. rightward by$50 billion at each price level.
D. leftward by $50billion at each price level.

Answer 1

Answer:

Option (C) is correct.

Explanation:

Given that,

Change in investment spending = $10 billion

Marginal propensity to consume, MPC = 0.8

Therefore, the magnitude of shift in aggregate demand will be determined by multiplying the spending multiplier with the change in investment.

Spending multiplier:

= 1/ (1 - MPC)

= 1/ (1 - 0.8)

= 5

Change in aggregate demand:

= Increase in investment spending × Spending multiplier

= $10 billion × 5

= $50 billion

Therefore, the aggregate demand curve will shift rightward by $50 billion.