If the marginal propensity to consume is 2/3, and there is no investment accelerator or crowding out, what would happen to AD or AS, the price level (P) and the real GDP (Y) if government expenditures increases by $20 billion? Also show what happens graphically.

Take a shot, what do you think. Hint, the government spending multiplier is 1/mps = 1/.33333 = 3.

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To determine the effects on aggregate demand (AD), price level (P), and real GDP (Y) when government expenditure increases by $20 billion, we need to consider the concept of the multiplier effect.

The multiplier effect refers to the phenomenon where an initial change in spending leads to a greater final impact on the overall economic activity. In this case, we'll assume that the marginal propensity to consume (MPC) is 2/3, which means that for every additional dollar earned, people will spend 2/3 of it and save the remaining 1/3.

To calculate the multiplier, we can use the formula:

Multiplier = 1 / (1 - MPC)

In this case, the multiplier would be:

Multiplier = 1 / (1 - (2/3))
= 1 / (1/3)
= 3

Now let's analyze the effects graphically:

1. Aggregate Demand (AD) Curve:
When government expenditure increases, it directly contributes to the aggregate demand curve. The aggregate demand curve will shift to the right by the amount of the increase in government expenditures. This is because increased government spending leads to higher overall demand in the economy.

2. Price Level (P):
The increase in government expenditures will result in higher demand for goods and services in the economy. This increased demand may lead to a rise in prices, assuming there is no significant increase in aggregate supply.

3. Real GDP (Y):
The increase in government expenditures will have a multiplier effect on the real GDP. As the initial increase in government spending leads to an increase in aggregate demand, businesses will respond by increasing production to meet the higher demand. This increase in production will then lead to an increase in the real GDP.

However, since we assume there is no investment accelerator or crowding out, there will be no additional effects on AD, P, or Y beyond the initial increase in government expenditure.

In summary:
- AD will shift to the right.
- P may increase due to higher demand.
- Y will increase due to the multiplier effect.

Note: It's important to keep in mind that these are simplified assumptions, and in reality, the economy is much more complex with various interdependencies and constraints.