Question

Suppose that in the flexible-price full-employment model of this chapter the government increases taxes and government purchases by equal amounts. The tax increase reduces consumption spending. What happens qualitatively (tell the direction of change only) to investment, net exports, the exchange rate, the real interest rate, and potential output?

Answer #1

Government increases taxes and purchases by equal amounts. It implies that there shall be rise in expenditure or aggregate demand by only one time. Expenditure multiplier is greater than negative tax multiplier. Hence, overall net demand shall rise.

Investment shall rise due to rise in demand.

Net exports would fall due to rise in the import owing to rise in aggregate demand in economy.

Exchange rate is likely to fall due to rise in demand for import.

Inflation will rise, hence real interest rate will most probably fall.

Potential will rise due to increase aggregate demand.

Under a flexible exchange rate regime, the government decides to
conduct expansionary fiscal policy by increasing government
spending
a. What happens to equilibrium output, the interest rate, and
the exchange rate? Explain and show using the appropriate
graphs.
b. What happens to the components of aggregate demand:
consumption, investment, government spending and exports?

1. An economy has full-employment output of 5000. Government
purchases are 1000. Desired consumption and desired investment are
given by
Cd= 3600 - 2000r + 0.10Y
Id = 1200 - 4000r
where Y is output and r is the expected real interest rate.
(a) Find the real interest rate that clears the goods market.
Assume that output equals full-employment output.
(b) Calculate the amount of saving, investment, and consumption
in equilibrium.

Suppose the economy is at potential GDP (i.e. full employment),
and the government increases the amount of government purchases to
increase aggregate demand. What can be one potential drawback of
this fiscal approach? Use graphs to explain where relevant.

suppose the economy is at potential GDP(i.e. full employment),
and the government increases fiscal spending(i.e. does more
government spending) to increase aggregate demand. what can be one
potential drawback of this approach? use graphs to explain where
relevant.

If the economy is close to full employment, an increase in
government purchase (G) will __________ in the long run.
a) reduce all of consumption, net exports and investment through
the wealth, interest rate and international trade effects
b) reduce both consumption and investment through the wealth and
interest rate effects
c) reduce only net exports through the international trade
effect reduce only investment through the interest rate effect
d) reduce only consumption through the wealth and interest rate
effects

Suppose the Canadian government decides it wants to use fiscal
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carefully explain whether and how an increase in government
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rates.
Suppose Canada is a small open economy initially in Long Run
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downward
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A real Keynesian model of a mixed economy with a marginal
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output.
A) What change in government spending would bring about full
employment? Be sure to calculate the government spending
multiplier.
B) The resulting increase in real output have driven up real
interests rates from 3% to 4% and those higher real interest rates
reduced investment by...

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