government acts as an automatic stabilizer
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Please assist me with the following set of questions.
Relevant diagrams are highly recommended.
(Some of the questions are adapted from Mankiw 2003.)
1. a. Discuss with the aid of diagrams the short run effect on output,
unemployment, general price level and interest rate with an
increase in both consumption and investment expenditure
(assuming the economy is initially at full employment). (8 )
b. What is the term that we use to describe the adjustment in general
price level that is observed in 'part a' if it is continuous. (2 )
c. Discuss with (AD-AS) diagram what kind of fiscal policy can be
adopted to restore the economy back to the full employment
equilibrium. (7 )
d. Suggest two ways to implement the kind of fiscal policy you
proposed in 'part c'. (2 )
e. Suppose what happened to the general price level that you found
in 'part a' is unexpected, determine who (creditor or debtor) will
gain and who will lose. (2 )
f. Suppose the government does not implement any kind of policy
that you discussed in 'part c'. Explain with diagram what would
be the long run equilibrium. (7 )
g. From the result that you derived in 'part c' and 'part f', explain
why the government may still implement stablization policy in
the short run. (3 )
2. a. Consider two policies - a tax cut that will last for only one year,
and a tax cut that is expected to be permanent. Which policy will
have greater impact on consumer spending and aggregate
demand? Explain. (6 )
b. Explain how unemployment benefit from government acts as an
automatic stabilizer. (6 )
c. Suppose that the Fed of US unexpectedly decreases the money
supply. What will happen to the US unemployment in the short
run and the long run respectively? (6 )
You will need to supply the diagrams as I have no means to do it here.
1a) An increase in both consumption and investment expenditure
(assuming the economy is initially at full employment), means the demand curve is pushed out first and as the effects of increased investment come into effect, the supply curve is also pushed out. This delay causes the following effects: output increases to supply the increased demand; unemployment is already non-existent according to the question, but I suppose those who have left the work force could reenter as wages increase to attract employees to produce the increased output; prices will increase as demand outstrips supply; interest rates will increase as the Fed tries to hold off the increasing inflation.
b) New equilibrium price level
c) The government can do several things to increase employment, depending ...
Explain how unemployment benefit from government acts as an automatic stabilizer.