Question

2.       Use the equation of exchange (M^s x V = P x Y) to answer the following:                 15 pts

If Ms rises what would the Keynesians say will happen, all other things equal?

If the government cuts taxes to promote spending what would the Keynesians say would happen, all other things equal?

If Y starts to fall then what would the Keynesians say would happen, all other things equal?

3.         Equilibrium GDP is $5000 while full employment is $6000.                                   20 pts

What kind of gap is this?

What would the Keynesians say the government should do?

The correct economic policy would cause Aggregate (Demand or Supply) to (rise or fall)?

Answer 1

2 We have an equation of exchange (Ms x V = P x Y)

a) If Ms, Keynesians who believe that prices are sticky in the short run, will argue that this will reduce the velocity of money because Y is influenced by Government action and P is also fixed. So real GDP or Y will remain fixed and V falls.

b) If the government cuts taxes to promote spending, Keynesians will argue that this will stimulate the aggregate demand will increase the real GDP or Y in short run.

c) If Y starts to fall then Keynesians would argue that velocity will fall in tandem because money supply is fixed and so is the price level in the short run. Hence V falls.

3) Equilibrium GDP is $5000 while full employment is $6000.

Because full employment GDP > current equilibrium GDP, there is a recessionary gap or negative output gap.

Keynesians would argue for expansionary fiscal policy with increases government spending or reduces taxes to stimulate aggregate demand

The correct economic policy would cause Aggregate Demand to rise as consumer spending governent spending and investment spending all will rise.