Question 5

5. Fiscal policy, the money market, and aggregate demand Suppose there is some hypothetical economy in which households spend $0.50 of each additional dollar they earn and save the $0.50 they have left over. The following graph plots the economy's initial aggregate demand curve (AD1). Suppose now that the government increases its purchases by $3 billion. Use the green line (triangle symbol) on the following graph to show the aggregate demand curve (AD2) after the multiplier effect takes place. Hint: Be sure the new aggregate demand curve (AD2) is parallel to ADi. You can see the slope of AD, by selecting it on the following graph. (?) 118 A 114 AD 2 112 AD 110 AD, 108 PRICE LEVEL 106 104 102 100 100 102 104 106 108 110 112 114 118 OUTPUT (Billions of dollars) The following graph plots equilibrium in the money market at an interest rate of 6% and a quantity of money equal to $45 billion.Show the impact of the increase in government purchases on the interest rate by shifting one or both of the curves on the following graph. (?) 12 Money Supply 10 Money Demand Money Supply IN TEREST RATE 6 Money Demand 2 15 30 45 60 75 90 MONEY (Billions of dollars) Suppose that for every increase in the interest rate of one percentage point, the level of investment spending declines by $0.5 billion. Based on the changes made to the money market in the previous scenario, the new interest rate causes the level of investment spending to _ by Taking the multiplier effect into account, the change in investment spending will cause the quantity of output demanded to_ by at every price level. The impact of an increase in government purchases on the interest rate and the level of investment spending is known as the effect. Use the purple line (diamond symbol) on the graph at the beginning of this problem to show the aggregate demand curve (ADy) after accounting for the impact of the increase in government purchases on the interest rate and the level of investment spending. Hint: Be sure your final aggregate demand curve (AD);) is parallel to AD, and D2. You can see the slopes of AD, and AD, by selecting them on the graph. Grade It Now Save & Continue6. Changes in taxes The following graph plots an aggregate demand curve. Using the graph, shift the aggregate demand curve to depict the impact that a tax hike has on the economy. @ O Aggregate Demand PRICE LEVEL Aggregate Demand B T O 4 t 4 t 1 o 10 20 30 40 50 60 QUTPUT Suppose the governments of two very similar economies, economy N and economy M, implement a tax cut of equal size. The tax cut in economy N is permanent, while the tax cut in economy M is temporary. The economies are otherwise completely identical. The tax cut will have a larger impact on aggregate demand in the economy with the v . m Save & Continue