Assume the government increases spending by $100. Explain: (1) through the multiplier process, why income Y...

Assume the government increases spending by $100. Explain: (1) through the multiplier process, why income Y will increase; and (2) why the money market (LM Curve) cause investment to fall and thus the increase in GDP to be less than hoped for. I NEED MATH AND GRAPHs please!

Expert Solution

ans....

Assume the government increases spending by $100. Any increase in the government purchases initially increases the income by the exact amount which is here $100. This is due to the fact explained by Keynesian cross as well as National income identity

Y = C + bYd + I + G

But in the subsequent rounds, disposable income increases by MPC×?G. A crowding out effect is the tendency of a fall in the private investment when government budget deficit is financed through the market for loanable funds. When the government spending is increased, the demand for loanable funds shifts to the right.

At the initial interest rate, there is a competition among borrowers and quantity demanded exceeds quantity supplied. This increases the real interest rate and decreases private investment. Here also, the private investment demand falls on the account of higher interest rate. This is the crowding out of private investment

Rahul Sunny answered 2 years ago

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