Question

Assume that the MPC is .80. If the Federal Reserve decreases the money supply, interest rates rise, and investment spending falls by $10 billion, then aggregate demand is most likely to:
A. Increase by $10 billion
B. Decrease by $10 billion
C. Increase by $50 billion
D. Decrease by $50 billion

Answer 1

Answer:

D) Decrease by $50 billion

Explanation:

If the marginal propensity to consume (MPC) = 0.8, that means that the marginal propensity to save (MPS) = 1 - MPC = 1 - 0.8 = 0.2

If investment spending falls by $10 billion, then aggregate demand will decrease by: $10 billion / 0.2 = $50 billion.