Suppose the federal government unexpectedly decreases its spending. Using the IS-LM model, explain how this contractionary...

Suppose the federal government unexpectedly decreases its spending.

Using the IS-LM model, explain how this contractionary fiscal policy affects the real interest rate, r, and total output, Y , in both the short run and the long run.

What happens to consumption, C, investment, I, and government expenditure, G, in the short-run?

What happens to C, I, G, and r in the long- run?

(Note: For full credit, you must provide a brief explanation for why each variable changes or remains constant.)

Solutions

Expert Solution

in short run --

G----- decreases due to decrease in government spending

I------decreases due to decrease in AD

C---- decrease in AD leads to decrease in consumption

in long run-----

G--decreases

I---increases

C--consuption increases

raesons for increase or decrease in the C,I,G is given in the fig itself

i hope my answer is clear now

Rahul Sunny answered 1 year ago

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