Question 15

Government spending increase of $10 billion raises aggregate demand by $100 billion.

An increase in government spending of $10 billion, when the marginal propensity to consume (MPC) is 0.9, results in a total increase in aggregate demand (AD) of $100 billion due to the multiplier effect.

A) $9 bn

This option is incorrect because it does not account for the multiplier effect that results from the increase in government spending. With an MPC of 0.9, the multiplier is calculated as 1/(1-MPC), which equals 10, meaning the overall increase in AD would be significantly higher than $9 billion.

B) $10 bn

This choice is incorrect as it only reflects the initial increase in government spending and fails to consider the multiplier effect. The total increase in aggregate demand would be much higher than just the initial expenditure due to subsequent rounds of consumption generated by the spending.

C) $90 bn

This option is incorrect as it underestimates the total impact of the government spending increase. While it recognizes some level of multiplier effect, it does not accurately calculate the total increase in AD, which extends to $100 billion with the correct application of the MPC.

D) $100 bn

This option is correct as it reflects the total increase in aggregate demand resulting from the government spending increase. Given an MPC of 0.9, the multiplier is 10, leading to a total increase in AD of $100 billion when $10 billion is spent.

Conclusion

The correct answer of $100 billion accurately represents the significant impact of government spending on aggregate demand when considering the multiplier effect with an MPC of 0.9. All other options fail to properly account for the multiplier, either underestimating or miscalculating the total increase in AD from the initial government spending.