In the Aggregate Expenditures Model, how does a decrease in government spending affect the aggregate expenditure (AE) line?

• A. It flattens the AE line, decreasing the marginal propensity to save.
• B. It shifts the AE line downward, reducing equilibrium output.
• C. It makes the AE line steeper, increasing the marginal propensity to consume.
• D. It shifts the AE line upward, increasing equilibrium output.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the Aggregate Expenditures (AE) model, where the AE line represents total spending in the economy at different levels of output (income). The AE line is typically expressed as \(AE = C + I + G + NX\), where \(C\) is consumption, \(I\) is investment, \(G\) is government spending, and \(NX\) is net exports.
2. Step 2: Recognize that government spending (\(G\)) is an autonomous component of aggregate expenditures, meaning it does not depend on the level of income. Therefore, a change in \(G\) shifts the entire AE line up or down without changing its slope.
3. Step 3: Analyze the effect of a decrease in government spending. Since \(G\) decreases, the AE line shifts downward by the amount of the decrease in \(G\), reducing total planned spending at every level of output.
4. Step 4: Understand that the slope of the AE line is determined by the marginal propensity to consume (MPC), which is the change in consumption resulting from a change in income. A change in \(G\) does not affect the MPC, so the slope of the AE line remains unchanged.
5. Step 5: Conclude that a downward shift in the AE line reduces equilibrium output because the new intersection of the AE line with the 45-degree line (where \(AE = Y\)) occurs at a lower level of output.