a) Suppose that there is an exogenous unexpected decline in consumption spending by households. Use the IS-LM, AD-AS model to derive the short-run and long-run effects on i, P, and Y. [assume that there is no change in either monetary or fiscal policy and that the economy moves immediately to the new intersection of the IS & LM curves.]
b) Indicate the full multiplier effect of this decline in consumption on your graph. What is the implicit assumption that underlies the expenditure multiplier? Explain why the decrease in Y in the short run is less than the full multiplier effect. What is the value of the expenditure multiplier in the long run? What component of aggregate demand rises to offset the decline in C (in the long run), and what makes this happen?