Question

If the MPC is .8 and there is a $10 million increase in investment spending, then the aggregate demand curve will shift up and to the right by:
A) $50 million.
B) $12.5 million.
C) $8 million.
D) $2 million.

Answer 1

Answer: Option (A) is correct.

Explanation:

Given that,

Marginal propensity to consume (MPC) = 0.8

Increase in investment spending = $10 million

Marginal propensity to save (MPS) = 1 - MPC

                                                         = 1 - 0.8

                                                         = 0.2

Spending multiplier = $\frac{1}{MPS} \times change\ in\ investment\ spending$

                                 = $\frac{1}{0.2} \times 10,000,000$

                                 = $50 million

Therefore, If the MPC is .8 and there is a $10 million increase in investment spending, then the aggregate demand curve will shift up and to the right by $50 million.