Suppose that government spending makes private firms more productive, e.g., spending on roads and bridges might reduce transport costs.

2. (25 points). Suppose that government spending makes private firms more productive, e.g., spending on roads and bridges might reduce transport costs. (a) Using the production possibilities graph described in chpt. 5 of the text and in Lecture 5, show how an increase productive government spending could increase household welfare. (b) Show that the equilibrium effects on consumption and hours worked are ambigu- ous, but but that output definitely increases. Hint: Consider the induced income and substitution effects