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

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

Answer: (A)

Verified step by step guidance

1. Recall that in the Aggregate Expenditures (AE) model, the AE line represents total planned spending in the economy, which is the sum of consumption (C), investment (I), government spending (G), and net exports (NX). Mathematically, this is expressed as \(AE = C + I + G + NX\).
2. Understand that government spending (G) is an autonomous component of aggregate expenditure, meaning it does not depend on the level of income (Y). Therefore, a change in G shifts the entire AE line up or down without changing its slope.
3. Recognize that a decrease in government spending reduces the autonomous spending component, which causes the AE line to shift downward by the amount of the decrease in G.
4. Note that the slope of the AE line is determined by the marginal propensity to consume (MPC), which reflects how consumption changes with income. Since a change in G does not affect MPC, the slope of the AE line remains unchanged.
5. Conclude that a downward shift in the AE line leads to a lower equilibrium output because the new intersection point between the AE line and the 45-degree line (where \(AE = Y\)) occurs at a lower level of income.