A . If aggregate expenditure falls by $5 million, and the MPC is 0.8, explain the process that will drive the economy to a new equilibrium level. b. What will be the final result of this initial change?
a . The initial $5 million decrease in aggregate expenditure will cause national income to fall by $5
million. People will respond to this change by cutting consumption spending by $4 million (= $5
million × 0.80). This second decrease in aggregate expenditure will cause national income to fall by $4
million, triggering an additional $3.2 million (= $4 million × 0.80) decrease in consumption spending.
This will cause successive cuts in income and consumption, each smaller than the previous one.
b. The income multiplier in this case is 1/(1 – 0.8) = 5 . This means that national income will fall by $5 for
every $1 initial change in aggregate expenditure. Therefore, the cumulative effect is that national
income will fall by $25 million (= $5 million × 5).
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