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In 2006, Congress estimated that the cost of the Iraq War was approximately $100 billion a year. Since the US gov't was running a budget deficit at the time, assume that the war was financed by gov't borrowing. How does the equilibrium interest rate and private investment change in response to government expenditure on the war?

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Anne Gillian Duero
Anne Gillian DueroLv10
28 Sep 2019

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Related questions

1) If the tax multiplier is -1.5 and a $200 billion tax increase is implemented, what is the change in GDP, holding everything else constant? (Assume the price level stays constant.)

2) Suppose real GDP is currently $12.5 trillion and potential real GDP is $13 trillion. If the president and the Congress increased government purchases by $500 billion, what would be the result on the economy?

3) Suppose the federal budget deficit for the year was $100 billion and the economy was in a recession. If the economy had been at potential GDP, it is estimated that tax revenues would have been $60 billion higher and government spending on transfer payments $50 billion lower. Using these estimates, what was the cyclically adjusted budget deficit or surplus for the year?

4) How could the existence of an unemployment insurance system or other transfer programs have reduced the severity of the Great Depression?

Consider a small open economy in which aggregate expenditures, AE, is the sum of consumption spending by households, investment spending by firms, government expenditures and net exports. You may assume that net exports are independent of real GDP and taxes are lump‐sum. The numbers in the table below are in billions.

Real GDP Consumption Investment Gov't Expend. Net Exports Taxes Aggregate Expenditures
1000 1430 120 50 -100 160 A
2000 B 120 50 -100 160 2250
3000 2930 120 50 -100 160 3000
4000 3680 120 50 -100 160 3750
5000 4430 120 50 -100 160 4500

a. (4 pts) For the table below, calculate the missing values, A and B. b. (2 pts) From the table above, what kind of situation is the country in with regards to the trade balance (i.e. do we have a trade surplus or deficit)? What kind of situation is the country in with regards to the domestic balance (i.e. is the government running a deficit or surplus)? c. (4 pts) Use the table above to calculate the slope of the AE curve. [Hint: Recall that the slope of the AE curve is the additional increase in aggregate expenditures arising from an increase in GDP.] d. (4 pts) Recall that the Aggregate Expenditure function is written as: AE = AE0 + (slope of AE) *Y where AE0 is Autonomous Expenditures. Use the table in part (a) and your answer to part (c) above to calculate Autonomous Expenditure AE0. [Hint: Calculate induced expenditures for any given level of GDP, and use your answer to figure out AE0] e. (2 pts) In the table above, what is the value of real GDP in equilibrium? f. (4 pts) Suppose that the government decides to spend 500 billion more. By calculating the multiplier (or any other way), calculate the value of the new equilibrium value of real GDP!

The following equations represent the behavior of a given economy.

C = 100 + 0.6YD

I = 100+0.2Y−400i

G = 300

T = 400

(M/P)s= 160

(M/P)d = 0.4Y – 2,400i

C is consumption; YD is disposable income; I is investment; G is government expenditure; T represents taxes; (M/P)s is money supply; (M/P)d is money demand; and i is the interest rate.

A) Write an expression for goods market equilibrium (the IS relationship).

B) Write an expression for financial market equilibrium (the LM relationship).

C) What are the levels of income and interest rate that bring the goods and financial market into equilibrium? What is the level of investment in the equilibrium?

D) In this example, the government is initially running a surplus. What happens if G increases to the point when the government has a balanced budget? Does C increase, decrease or stay constant? Does I increase, decrease or stay constant? Does i increase, decrease or stay constant?

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