Show the impact of the increase in government purchases on the interest rate by
ID: 1205609 • Letter: S
Question
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. Suppose that for each one-percentage-point increase in the interest rate, the level of investment spending declines by $1 billion. The change in the interest rate (according to the change you made to the money market in the previous scenario) therefore causes the level of investment spending to by. After the multiplier effect is accounted for, the change in investment spending will cause the quantity of output demanded to by at each Price level. The imPact 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 ro show the aggregate demand curve (AD_3) after accounting for the impact of the in cease in government purchases on the interest rate and the level of investment spending.Explanation / Answer
1. The money demand curve would shift to the right because with an increase in government spending, the demand for money also increases because it triggers increase in income level with multiplier effect. As the demand curve shifts up to right, the new equilibrium would be established where the demand and supply curve intersects and the new interest rate would be 2%.
2. Fall.
Interest rate are investment are inversely related. With an increase in interest rates, the investment would fall.
3. $0.5billion.
The interest rates had gone up by 0.5%, given than the 1% increase in interest rate declines the investment by $1billion, so 0.5% interest rates would decline it by $0.5 billion.
4. Fall.
Investment is a component of aggregate demand. Fall in investment would lead to fall in aggregate demand.
5. $0.5 billion.
Investment falls by $0.5billion and so is the aggregate demand at each price level.
6. Crowding out effect.
With the increase in government spending, the government generally borrows from the money money, with money supply being constant, the interest rates bid up, which crowds out the private investment.
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