Question

Question 5 [25 pts]

Suppose the government increases its expenditures for a short term. What would the macroeconomic effects be? Based on the results of your analysis, do you think variations in government expenditures could explain the fluctuations we observe in business cycles? Why or why not?

Answer 1

Ans

Below mentioned are the macroeconomic effects of the increase in government expenditure :

1. Economic Growth.

The increase in government spending leads to higher economic growth since government spending on improving infrastructure facilities leads to increase productivity and growth in the long run aggregate suppy.

2. Interest Rates.

The increase in government spending leads to increase in tax burden on people leading to less savings in their hands and reduction in private spending and investment this ultimately increases the interest rates.

3. Inflation.

The increase in government spending leads to inflation due to rise in the price of goods and services created by multiplier effect. Since if the unemployed gets the job he will have more income to spend thus leading to increase in aggregate demand and ultimately inflation.

Yes , the variations in the government expenditures explains the fluctuations observed in the business cycle as the impact of increase in government spending also depends upon the state of the economy. Since if the economy is in full capacity increase in government expenditure will cause inflationary pressures and little increase in Gross Domestic Product whereas if the economy is in recession , and government borrows from the private sector it acts as a expansionary fiscal policy and boost the economic growth.