Question

1. In 2016 Obama’s administration presented a budget plan. It proposed an increase in defense
spending by $54 billion (more than a 10% raise):

a. Determine the effects of the policy on loanable funds market. Explain, use graphs and math.
What is the effect on the interest rate?

b. Use the aggregate demand model with positive slope to determine the effect of the policy
on national income. Use the math and graph.

Answer 1

Demand of funds: Government expenditure + Investment

Supply of funds= savings + Taxes

In equilibrium: G+I=S+T, because G increases by 10%, (S+T) has to rise as well by 10% to be in equilibrium. The interest rate increases.

2)

National Income= Consumption+Investment+Government Expenditure, of which G rises by 10%, hence aggregate demand and national income also rises by more than 10% due to multiplier effect.