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Consider the Keynesian model with a flexible price level and flexible money wage. Using the IS-LM...

Consider the Keynesian model with a flexible price level and flexible money wage. Using the IS-LM and AD-AS diagram, explain the effects on output, priceand interest rate,given an increase in government spending.

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Answer #1

Aggregate demand = Consumption + Investment + Government spending + Exports - Imports

Rise in government spending will raise aggregate demand in an economy which will shift AD curve to its right from AD to AD1 which will increase price level from P to P1 and output level from Y to Y1.

Rise in aggregate demand will shift IS curve to its right from IS to IS1 which will raise rate of interest from "i" to "i1" and output level from "Y" to "Y1".

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