The impact of a $500 million increase in government spending can be illustrated by adjusting the graph as follows.
Firstly, the government spending line (G) will shift upwards by $500 million, increasing the total spending. Secondly, the aggregate expenditure line (C + I + G) will shift upwards by $125 million (0.25 x $500 million = $125 million) as the marginal propensity to save (MPS) is 0.25.
As a result, the equilibrium output from the previous level of Y1 to a new level of Y2 will increase. This will lead to an increase in real GDP and an increase in the price level. In conclusion, the $500 million increase in government spending will result in an increase in the level of aggregate expenditure, real GDP, and price level.
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