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AE Model and the Multiplier quiz

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  • What does the multiplier effect describe in the aggregate expenditure model?
    It describes how an initial increase in spending leads to a proportionally larger increase in GDP.
  • Which components make up aggregate expenditures in the AE model?
    Aggregate expenditures include consumption, investment, government purchases, and net exports.
  • How is consumption defined in the AE model?
    Consumption is a base amount plus the marginal propensity to consume times disposable income.
  • What happens to equilibrium GDP when investment spending increases?
    An increase in investment spending shifts the aggregate expenditures curve upward, resulting in a higher equilibrium GDP.
  • What determines the slope of the aggregate expenditures curve?
    The slope is determined by the marginal propensity to consume (MPC).
  • How do you calculate the multiplier in the AE model?
    The multiplier is calculated as 1 divided by (1 minus MPC).
  • If the MPC is 0.5, what is the value of the multiplier?
    The multiplier is 2, since 1 divided by (1 - 0.5) equals 2.
  • What is the effect of a \$1 billion increase in investment spending when the multiplier is 2?
    It results in a \$2 billion increase in GDP.
  • Why does the multiplier effect result in a larger increase in GDP than the initial spending boost?
    Because the initial spending circulates through the economy, increasing consumption and production multiple times.
  • How does the marginal propensity to consume (MPC) affect the multiplier?
    A higher MPC increases the multiplier, leading to a larger total increase in GDP.
  • What is the formula for total increase in GDP due to the multiplier effect?
    Total increase in GDP = multiplier × initial spending boost.
  • How can government purchases impact GDP during a recession according to the multiplier effect?
    Increased government purchases can substantially boost GDP by triggering the multiplier effect.
  • What happens to the aggregate expenditures line when investment spending increases?
    The aggregate expenditures line shifts upward, reflecting higher spending at every level of GDP.
  • What role does the 45-degree line play in the AE model graph?
    It represents points where aggregate expenditures equal GDP, indicating equilibrium.
  • Why is the multiplier effect important for economic policy-making?
    It shows that policy actions like increased spending can have amplified effects on GDP, especially in times of economic downturn.