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Analyzing the effect of change in MPC on aggregate expenditure

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Suppose MPC is 0.8 initially. Households then change their behavior so that the MPC falls to 0.75. What happens to aggregate expenditures? Why?

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MPC represents the fraction of additional income that is used for consumption expenditures. Higher value of MPC means that people will spend more of every additional dollar they earn. Lower value of MPC indicates that the ...

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Solution discusses the impact of changes in MPC on aggregate expenditure.

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Analysis of IS/LM curves

1 Carefully explain and show graphically how each of the following changes would effect the shape of the IS curve:
a) The MPC becomes bigger.
b) Investment becomes more sensitive to changes in the real interest rate.

2 In the State of the union address in January 2002, President Bush announced that he would ask Congress to approve substantial increases in defense spending to counter terrorism and significant reductions in taxes. Show:
a) The short-run effects of his policy on aggregate Expenditure curve and the equilibrium level of GDP.
b) What the effects would be on IS/LM curves.

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