Assigment 5 .docx - Q1 a(1 In this situation when Autaria has a law that requires its government to maintain a balance budget a temporary increase in

Assigment 5 .docx - Q1 a(1 In this situation when Autaria...

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Q1: a) (1) In this situation, when Autaria has a law that requires its government to maintain a balance budget, a temporary increase in government spending will lead to an equal increase in taxes. If there is $1 increase in government spending, aggregate demand will be directly increasing by $1. However, $1 increase in taxes would reduce aggregate demand by less than $1 because consumption level is a function of disposable income and C will fall less than $1. Therefore, after a $1 increase in government spending and an equal increase in taxes will increase, the overall aggregate demand will increase, resulting that output will be affected. In other words, Autaria’s government can use a temporary increase in government spending to increase aggregate output in the short run under this situation. (2) According to the above answer, a permanent increase in government spending will increase overall aggregate demand, leading to DD curve shifting to right (DD 2 ). Then, the real exchange rate will decrease and let nominal
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