Question

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

Answer 1

A. Reduce all consumption,net exports and investment through weath , interest rate and international trade effect.

Solution: this is because , the economy is already in close to full empowerment level, expansion of govt spending will directly impact the private spending capacity ,as the money in the economy is spent by the govt. Due to this, private capacity to consume is reduced, imports rise leading to deficit in the economy and investment also fall.

Hence in long run all three parameters are negatively affected with rising govt purchase.