a. Suppose the government spends more on building new infrastructure. Assume tha

Question

a. Suppose the government spends more on building new infrastructure. Assume that the new infrastructure projects are useful and make the economy more efficient. What is the effect on the long-run level of output and the price level? Concentrate on the aggregate supply effects. Ignore the issue of how the government finances the new program.
b. Suppose the government finances the increased expenditures on infrastructure by borrowing. What effect will this have on the long-run level of output and the price level? Concentrate on the aggregate supply effects. Ignore the effect on net exports.

Explanation / Answer

A) New infrastructure (i.e. oil pipelines) makes it easier for companies to transport stuff (i.e. oil). Therefore the price of inputs decreases and aggregate supply increases. --> AS shifts to the right, GDP increases and price level decreases. B) The government borrows large amounts of money.--> interest rate increases --> investment decreases --> long run supply decreases. Since aggregate supply increases and decreases, the effect is indeterminate.

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