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Fiscal Policy: Government Expenditures, Revenues, Budget, Debt

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Fiscal Policy: Government Expenditures and Revenues, Budget, National Debt

1. Do all government purchases have the same effect on aggregate demand? Defend your answer with economic reasoning.

2. Suppose a country increases government purchases by $100 billion. Suppose the multiplier is 1.5 and the economy's real GDP is $5,000 billion.

a. In which direction will the aggregate demand curve shift and by how much?

b. Why is the change in real GDP is likely to be smaller than the shift in the aggregate demand curve?

3. What is "crowding out," and how does it reduce private investment?

a. Given that only certain types of government expenditures crowded out private investment, what are the implications for fiscal policy choices?

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Solution Preview

1. No. Government spending increases the G component of AD, but domestic government spending also stimulates additional consumption (C) spending in its country. Government purchases of foreign goods and services do not contribute to additional consumption spending and so have a smaller effect on AD. Also, when governments finance their purchases with borrowed money, ...

Solution Summary

This solution explains why not all government expenditures have the same effect on Aggregate Demand (AD), why the change in real GDP does not always match the change in AD, and the implications of the "crowding out effect" for fiscal policy decisions.

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