Question

Suppose Congress decides to reduce the budget deficit by cutting government spending. Use the Keynesian-cross model to illustrate graphically the impact of a reduction in government purchases on the equilibrium level of income. Be sure to label:

1) the axes;

2) the curves;

3) the initial equilibrium values;

4) the direction the curve shifts;

5) the terminal equilibrium values.

Answer 1

In the above graph, the economy was initially at equilibrium at point "a", after the reduction in the government expenditure the new equilibrium will be at point "b". The number here is given only for reference. The arrows show the movement of the curves.