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When analysis is warranted, more credit will be given for answers that use the diagrams presented...

When analysis is warranted, more credit will be given for answers that use the diagrams presented in class. More credit will also be given for answers that include a “story” providing an intuitive explanation of the situation. For stats-book questions, more credit will be given for more specific answers.

9. Identify a change in fiscal policy that will shift the composition of output toward investment. Present a composition of output analysis to explain why the policy you suggest will tend to shift the composition of output toward investment.

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Ans. A fiscal contraction will lead to decrease in spending causing aggregate demand to fall leading to decrease in demand for money shifting the money demand curve leftwards from Md to Md’. This at given level of money supply causes interest rate to decrease from r to r’. This decrease in interest rate reduces cost of borrowing which induces investment increasing investment from I to I’.

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