Question

Real money demand: (M/p)^d = 0.5Y – 7,500r and money supply: Ms = 280, and P =1.

       Try to keep decimal fractions (like 0.0667) in the form of simple fractions (2/30) until calculating your final values for Y, r, and so forth.      

       f.     Now suppose that government spending increases by 500 to 700. Summarize the effects of the expansionary fiscal policy in part f by stating what happened to Y, r, C, I and the budget balance.

       g.    What is the size of the multiplier?

h.   Now suppose that the supply side of money (the real supply of money) is represented by the real interest rate: r = 8% (treat this interest rate as constant) and P =1.

              Obtain the amount of money demanded (M/P) ^d at this equilibrium point. What is the implied value for Money supply (M ^s)?

i.     Given the assumptions in the part h, how will your answers to part f and g change?

Answer 1

F) Government spending is also known as government expenditure it includes all govt. consumption investment and transfer payments.So govt spending increases,then it affect income(Y),consumpotion(C) and interest rate (r) & budget balances.

Economy has experiencing expansionary fiscal policy that means an increase in govt. spending or decreasing in taxation.The govt. used this policy in the time of recession to stimulates the economy , an increment in govt spending directly increases the demand for goods and services,it will helps risze in output and employment

Govt. spending increases by 500 to 700 , aggregate demand increases and increases in consumption income and output also increases,then interest rat e increases because of decreasing tax revenue of govt ,expansionary fiscal policy reduces investment in private sector.

G)SIZE OF THE MULTIPLIER +1/1-MPC

=here demand fun=M/p)^d = 0.5Y – 7,500r

MPC =.5

1/1-.5=2

Multiplier is 2