By how much must the government increase expenditures to shift the aggregate demand curve right by \$10 billion? Suppose that there are no crowding-out effects and the MPC is .6.

The expenditure by the government should be increased by \$4 billion.

Expert Answers

MPC, or marginal propensity to consume, refers to the willingness to spend money. For instance, if a person were given \$100 and they only spend \$80 of that, the marginal propensity to consume would be 80/100 = 0.8

If the financial situation requires an increase in aggregate demand, the government can do the same by increasing its expenditure. An increase in government expenditure by X increases the aggregate demand by a value greater than X and the ratio of the two is called the multiplier. The multiplier M = 1/(1 - MPC)

In the given problem, the MPC is equal to 0.6. In this case, the multiplier M = 1/(1 - 0.6) = 1/0.4 = 2.5

An increase in government expenditure by X would increase the aggregate demand by 2.5X.

As the aim is to shift the aggregate demand curve to the right by \$10 billion, the government should increase its expenditure by 10/2.5 = \$4 billion.

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