When MPC = 0.9, $10 bn gov’t spending max change in AD:

Rationale

$100 bn government spending results in a maximum change in aggregate demand when MPC = 0.9.

With a marginal propensity to consume (MPC) of 0.9, the government spending multiplier can be calculated as 1/(1-MPC), which equals 10. Therefore, a $10 billion increase in government spending will lead to a maximum change in aggregate demand of $100 billion, demonstrating the amplifying effect of fiscal policy on the economy.

A ($9 bn) YOUR ANSWER

This choice incorrectly represents the maximum change in aggregate demand. The multiplier effect indicates that the total change in AD is significantly larger than the initial government spending. A figure of $9 billion does not reflect the calculation based on the MPC provided.

B ($10 bn) YOUR ANSWER

This option suggests that the change in aggregate demand is equal to the initial government spending, which is incorrect. While the initial spending amount is indeed $10 billion, the multiplier effect due to the MPC of 0.9 leads to a much larger maximum change in AD, specifically $100 billion.

C ($90 bn) YOUR ANSWER

While this figure is closer to the expected outcome, it does not accurately represent the total change in aggregate demand. The maximum change is derived from applying the spending multiplier to the initial government spending, resulting in $100 billion, not $90 billion.

D ($100 bn) CORRECT

This choice correctly reflects the maximum change in aggregate demand when MPC is 0.9. The calculation involves using the spending multiplier of 10, which is derived from the formula 1/(1-MPC), indicating that a $10 billion increase in government spending will ultimately lead to a $100 billion increase in AD.

Conclusion

The relationship between government spending and aggregate demand is amplified through the spending multiplier effect, especially when the marginal propensity to consume is high, as evidenced by the MPC of 0.9. Therefore, a $10 billion increase in government spending leads to a maximum change in aggregate demand of $100 billion. Understanding this relationship is crucial for effective fiscal policy implementation aimed at stimulating economic growth.

When MPC = 0.9, $10 bn gov’t spending max change in AD:

$100 bn government spending results in a maximum change in aggregate demand when MPC = 0.9.

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