Answer to Question #280096 in Macroeconomics for Nicole

Question

Suppose a country decreases government purchases by $100 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion.

a. In which direction will the aggregate demand curve shift and by how much?

b. Explain using a graph why the change in real GDP is likely to be smaller than the shift in the aggregate demand curve.

Answer 1

a.

The aggregate demand curve will shift to the left by $150 billion:

Since the decrease in government purchases is $100 and the multiplier is 1.5, we get it as follows:

$1.5\times100$ =$150 billion.

b.

The change in real GDP is likely to be smaller than the shift in the aggregate demand curve because the shift in aggregate demand curve to the left results in only a slight change in real GDP due to low pressure on the price level, as opposed to if the aggregate demand curve would have shifted to the left, resulting to a higher GDP due to upward pressure on the level of price.