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ps8_ans

# ps8_ans - the position of the aggregate demand function and...

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1)C 2)C 3)B 4)D 5)C 6)A 7)A 8)C 9)A 10)B 11)B 12)B 13)B 14)D 15)D 16)Increases in interest rates reduce planned investment. The decrease in investment reduces equilibrium output by a multiple amount due to the multiplier effect. Also, increases in interest rates increase the value of the dollar, reducing net exports, which reduce aggregate demand and equilibrium output by a multiple amount. 17)The increase in the money supply shifts LM to the right, increasing output to Y', above the natural rate Y*. The interest rate falls from i to i' . Excess demand increases the price level, reducing the real value of the money supply. The LM curve shifts back until the all pressure on prices is eliminated by the return to the natural rate of output. The initial and final levels of output and interest rate are the same. No real variables have changed. 18)Keynes realized that government spending and taxes could also affect

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Unformatted text preview: the position of the aggregate demand function and hence be manipulated to restore the economy to full employment. Students must draw the Keynesian cross diagram and show that according to Keynes's analysis Yad = C + I + G + NX. Thus, government spending adds directly to aggregate demand, while taxes do not affect aggregate demand directly. This is why when there are taxes disposable income does not equal aggregate output. It equals output Y minus taxes T: YD = Y - T. According to Keynes's analysis an equal increase in government spending and taxes in the economy that is in recession can restore full employment output as government spending leads to a multiplied change in aggregate output through the expenditure multiplier: (1/1-mpc) x G. The equal increase in taxes, only reduces consumer expenditure by mpc X T. Thus the final result is an increase in aggregate output....
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