Let's break down the problem step by step: ### **Step 1: Calculate the Spending Multiplier** The **spending multiplier** (also known as the Keynesian multiplier) is given by: \[ \text{Multiplier} = \frac{1}{\text{MPS}} \] Given: - \( \text{MPS} = 0.20 \) So, \[ \text{Multiplier} = \frac{1}{0.20} = 5 \] --- ### **Step 2: Calculate the Change in Aggregate Demand (AD)** An increase in **autonomous investment** shifts the AD curve **rightward** by the initial change **times the multiplier**. \[ \text{Change in AD (if price level fixed)} = \text{Multiplier} \times \text{Change in investment} \] \[ = 5 \times \$25\,\text{billion} = \$125\,\text{billion} \] --- ### **Step 3: Why the AD/AS Model May Yield a Different Result** However, the **AD/AS model** with an **upward-sloping SRAS curve** (not a horizontal curve) means: - As AD increases, both **real GDP** and the **price level** rise. - **Part** of the increase in AD is absorbed by higher prices (inflation), not just by increased output. **Therefore, the actual increase in equilibrium real GDP will be LESS THAN $125 billion.** --- ### **Step 4: Summary Table** | Model/Assumption | Change in GDP | |------------------------|------------------------| | Simple Keynesian (horizontal SRAS) | **$125 billion** | | Upward-sloping SRAS (AD/AS model) | **Less than $125 billion** | --- ### **Step 5: Final Answer** - **Equilibrium real GDP increases** (there is an increase). - **The increase is less than $125 billion.** --- ### **Explanation** In the **simple Keynesian model** (with a horizontal SRAS), all of the multiplier effect translates into higher real GDP. In the **AD/AS model with an upward-sloping SRAS**, rising prices "absorb" some of the impact, so the increase in real GDP is less than the full multiplier effect. --- ## **Final Answer** **Equilibrium real GDP increases, but the increase is less than $125 billion.**