Consider two closed economies that are identical except fortheir marginal propensity to consume (MPC). Each economy iscurrently in equilibrium with real GDP and total expenditure equalto $100 billion, as shown by the black points on the following twographs. Neither economy has taxes that change with income. The greylines show the 45-degree line on each graph.
The first economy's MPC is 0.5. Therefore, its initial totalexpenditure line has a slope of 0.5 and passes through the point(100, 100).
The second economy's MPC is 0.75. Therefore, its initial totalexpenditure line has a slope of 0.75 and passes through the point(100, 100).
Now, suppose there is an increase of $20 billion in investmentin each economy.
Place a green line (triangle symbol) on each of the previousgraphs to indicate the new total expenditure line for each economy.Then place a black point (plus symbol) on each graph showing thenew level of equilibrium output. (Hint: You can see the slope andvertical axis intercept of a line on the graph by selectingit.)
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TOTAL EXPENDITURE (Billions of dollars) 200 180 160 140 120 100 80 60 40 20 0 0 AE Line 20 40 MPC=0.75 45-Degree Line 60 80 100 120 140 REAL GDP (Billions of dollars) 160 180 200 New AE Line ++ New Equilibrium
In the first economy (with MPC = 0.5), the $20 billion increase in investment causes equilibrium output to increase by second economy (with MPC 0.75), the $20 billion increase in investment causes equilibrium output to increase by $ higher MPC is associated with a multiplier. Now, confirm your graphical analysis algebraically using the oversimplified multiplier formula: Multiplier = = 1 1-MPC For the first economy, with an MPC of 0.5, the effect of the $20 billion increase in investment is as follows: Change in Equilibrium Output = Change in Total Expenditure x Multiplier Using the same method, the multiplier for the second economy is X $60 billion. In the billion. Therefore, a