The diagram below shows an AD/AS diagram. The economy begins at \(E_{0}\) with output equal to \(Y^{*}\). Suppose the government in this closed economy increases \(G\) and finances it by running a deficit (borrowing). The \(A D\) curve shifts to the right.

a. How does the interest rate at \(E_{1}\) compare with that at \(E_{0}\) ? Explain.

b. Given your answer to part (a), how does investment at \(E_{1}\) compare with investment at \(E_{0}\) ?

c. Explain the economy's adjustment toward \(E_{2}\). What happens to the interest rate and investment?

d. What is the likely long-run effect for the economy from the fiscal expansion? Explain.

Transcribed Image Text:

Price Level AS' AS E Ep AD 0 Y* Real GDP "AD'