I am having a hard time with the following economic questions (See attached). Here is my approach:
Note about the curves: The graph below depicts an economy where a decline in aggregate demand has caused a recession. Assume the government decides to increase government purchases as fiscal policy to reduce the burden of this recession.
How much does aggregate demand need to increase to reach long-run equilibrium?
A: 100 billion Because that's the AD1-AS equilibrium to AD1-LRAS line
MPC =.75 (and thus MPS = .25)
How much do government purchases need to increase to shift aggregate demand by the amount you found in part 1)?
My logic: The expenditure multiplier = 1/MPS = 1/(.25) =4
Delta Y from 1) is 100 billion
Therefore, 4X= 100 (x = government purchases) leading to x = 25
Suppose the MPC is 0.6. To restore the economy to its long-run equilibrium, aggregate demand must be increased by i) ___________ and government purchases must be increased by ii) ________________
Delta Y is the same as 1), so it's 100 billion for i)
MPS changes to .6, so the multiplier is 1/.4 = 2.5, 100/2.5 = 40 billion in government purchases to restore long-run equilibrium.