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Keynesian theory aggregate demand

1. At the insistent urging of President Obama, Congress has enacted massive spending bills
totaling over $1 Trillion. This is sold to the public as "economic stimulus". What is the
purpose of this orgy of spending? Explain the macroeconomic rationale for this action by the
Federal government.
2. According to the (Keynesian) theory in does it matter what the money is
spent on?
3. How is the above stimulus bill going to be financed? According to the (Keynesian) theory
, does it matter where the money comes from?
4. Using common sense (and not Keynesian theory), discuss the amount of stimulative
effect we can expect, depending on how the "stimulus" is financed: by taxes, by borrowing
from the U.S. population, by borrowing from foreigners, or by borrowing from the Fed. What
are the long term consequences?

Solution Preview

1. The Congress has enacted massive spending bills over the last two years. The main reason for this spending 'orgy' is the fact that the US economy is just coming out of a severe recession, and the worst banking crisis in about 80 years! According to Keynesian theory aggregate demand (AD) of all sectors of the economy is the primary driving force of the economic well being. When aggregate demand is high firms produce more and everyone in the economy has access to more resources. The biggest component of AD is household consumption. Another major component is Gross Investment (I). In the recession gross investment in the economy fell drastically (by some measures the fall was more than 25%), and along with some fall in consumption it meant that AD fell by a lot. To revive this the government could have either waited for people and firms to start spending, or it could kick-start the process by increasing its own spending. The latter option is quicker and more effective, and this was the rationale used to ...

Solution Summary

Keynesian theory aggregate demand is examined.

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