Explain if this statement is true or false and why. (Take into consideration net
ID: 1125168 • Letter: E
Question
Explain if this statement is true or false and why. (Take into consideration net factor payments).
helow is sometimes used to argue that the total government 4. The fiure multiplier should be higher than unity. In the figure the expenditunt spending increases from Gi to G2 and the total demand gative for most o important? Whe domestic reside d by foreigners. d/or the U.S. g is a current accou . 4. The figure up by exactly the same amount. un a current acc t may make sen sumption over 1 1 by running a e. Second, pers borrowing is u ow for higher f r time in the unt surplus is holding taxe nanced by inc so as to incr orrowing is d ficit. Thus, a 1 the current United States ing this peri ment surpl decline in th s). This phe C+1+G Income a) What does the government expenditure multiplier mean and why always be t m the early government is it greater than unity in the figure? mechanisms of general equilibrium models are omitted in and how do the omissions affect the conclu- rnment expenditure multi- omenon, w the current t spending the above argument sions about the magnitude of the gove plier? rld, which t surplus a
Explanation / Answer
a) Government spending multiplier is derived from C + I + G = Y equation. It has a value of 1/1-MPC. Economic theory of fiscal policy indicates that government spending has multiplier impact on the economy because the money it spends on goods and services multiplies itself when it passes from hands to hands. It is greater than 1 because MPC is assumed to be less than 1 and greater than zero.
b) Keynesian cross overestimates the impact of government spending on aggregate demand because it considers aggregate supply is perfectly elastic. However, in general equilibrium models, SRAS is upward sloping which tends to reduce the actual increase in the aggregate demand perhaps because wages are not flexible to change. Also there are effects like crowding out that brings the shifts in the aggregate demand down when fiscal expansion reduces the funds available for private investment which now bears a higher rate of interest and so its quantity in the AD equation is reduced.
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