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Assume that capital is perfectly mobile, the price level is fixed, and the exchange rate is flexible. Now let the government increase purchases. Explain first why the equilibrium levels of output and the interest rate are unaffected. Then show whether the current account improves or worsens as a result of the increased government purchases of goods and services?

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Kritika Krishnakumar
Kritika KrishnakumarLv10
28 Sep 2019

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Related questions

Keynesian Multipliers: Suppose the president would like to stimulate the level of output in the economy by introducing a tax cut. However, he also would like to keep a balanced budget if possible. Let's consider if these two objectives can be consistent with each other. Assume a consumption function C = 100 + 0.75(Y-T), and let G = 100, T = 100, I = 100 (investment is not a function here of the interest rate).

a) First, suppose there is just a tax cut alone, lowering T from 100 to 90. Use the Keynesian multipliers to compute the change in output. Compute also the effect on government saving.Will the president be satisfied (did he get a rise in output and a balanced government budget)?

b) Now suppose he combines the tax cut with spending cuts to keep the budget balanced. So supposed taxes and government spending both are cut from 100 to 90. What is the effect on government saving and output? Will the president be satisfied?

c) Now suppose that the president instead uses a rise in government purchases to stimulate the economy, and then raises taxes to pay for these purchases. In particular, suppose government purchases and taxes both are raised from 100 to 130. Compute the effects on output and government saving. Will the president be satisfied now? Explain how this result is possible and why it is so different from the result in part (b) above.

A.

In response to a negative supply shock, the government decreases taxes. The most likely result of the government's tax decrease is:
a decrease in unemployment and a decrease in the aggregate price level.
a decrease in unemployment and an increase in the aggregate price level.
an increase in unemployment and an increase in the aggregate price level.
an increase in unemployment and a decrease in the aggregate price level.

B.

If the aggregate price level rises, holding everything constant, consumers will:
demand less aggregate output at all price levels resulting in a shift right of the AD curve.
find their purchasing power has increased and will purchase more goods and services leading to an increase in the aggregate output demanded.
need more money to purchase the same basket of goods which will lead to an increase in the demand for money leading to interest rate increases, and a reduction in the quantity of aggregate output demanded via a drop in investment demand.
need less money to purchase the same basket of goods which will lead to a decrease in the demand for money leading to interest rate decreases, and an increase in the quantity of aggregate output demanded via an increase in investment demand.

1. Suppose that real GDP is currently ​$13.55 trillion and potential real GDP is​ $14.0 trillion, or a gap of ​$500500 billion. The government purchases multiplier LOADING... is 2.52.5​, and the tax multiplier is 1.51.5. Holding other factors​ constant, by how much will government purchases need to be increased to bring the economy to equilibrium at potential​ GDP? Government spending will need to be increased by ​$____ billion. ​(Enter your response rounded to the nearest whole​ number.)

2. Suppose the government increases taxes by ​$120 billion and the marginal propensity to consume is 0.50. By how will equilibrium GDP​ change?

The change in equilibrium GDP​ is: ​$_____ billion. ​(Round your solution to one decimal​ place.)

3.

Westville, a small developed​ country, is experiencing a very high rate of inflation. Roma​ Anderson, a market research​ analyst, thinks that the high level of inflation is due to an acute shortage of goods available in the economy. According to​ her, the government should use expansionary fiscal policies to boost the economy.​ Meanwhile, Robert​ Simpson, a member of the finance​ ministry, is of the opinion that the high level of inflation is the result of excessive household spending. He suggests that the government should increase personal income tax rates to curb consumption demand.

Which of the​ following, if​ true, will strengthen​ Robert's claim that high consumer spending is the cause of high​ inflation?

A.

The number of discouraged workers in Westville has increased this year.

B.

Leading firms producing consumer durables have reported a decline in profits in recent times.

C.

There is consensus among leading economists and industry experts that the output gap in Westville is currently negative.

D.

The gender wage gap in Westville has increased substantially in the last few years.

E.

One of​ Westville's leading trading partners was recently hit by a severe recession.

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