Question

Assume the marginal propensity to consume 0.625. Assuming only the multiplier effect matters, ceteris paribus, a decrease in government purchases of $10 billion will shift
a. the aggregate demand curve to the left by about $26.7 billion.
b. the aggregate demand curve to the left by about $36.7 billion.
c. the aggregate supply curve to the right by about $26.7 billion.
d. the aggregate supply curve to the left by about $13.3 billion.
e. none of the above.

Answer 1

d. Ceteris paribus, a decrease in government purchases of $10 billion will shift the aggregate supply curve to the left by about $13.3 billion.

This is because when there is a decrease in government purchases of $10 billion, it will lead to a decrease in aggregate demand of $10 billion. This decrease in aggregate demand will then cause a decrease in the overall output of the economy.

In turn, this decrease in output will lead to a decrease in the aggregate supply of $13.3 billion (0.625 x $10 billion). Thus, the aggregate supply curve will shift to the left by about $13.3 billion, ceteris paribus.

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