Question

Suppose the economy is in long-run equilibrium and experiences an increase in consumer fear about the future of the economy (assume wages are sticky in the short run). In response, the federal government increases its spending by borrowing. If the government wants to increase spending in the economy by $5 trillion, by how much should it increase its own spending (more than, less than, or equal to $5 trillion) in the following circumstances?

a. Case 1: multiplier > 1

b. Case 2: 0 < multiplier < 1

c. Case 3: multiplier = 1

d. Why might Case 2 hold with this type of fiscal policy?

Answer 1

a) when multtiplier >1 , then the government has to increase by less than $5 trillion in order to increase the spending by $5 trillion , since the muliplier is greater 1 .

b) When mutliplier < 1, then the government has to increase more than $5 trillion to increase the spending the by $ 5 trillion.

c) Multiplier =1 , then the government has to increase equal to $5 trillion to increase the spending by $ trillion.

d) Because , Consumer are fear about the future of the economy , hence therefore they will hold the consumption and thus consumption decrease so mutliplier would also decrease.