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Stimulus effects on the economy

Using Keynesian cross model diagram, critically and briefly illustrate the short run and long run economic impact of Obama's stimulus package of $787 billion. (Hint: The impact will be in terms of major macroeconomic variables of US economy such as GDP growth, unemployment rate, and inflation.


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According to the Keynesian Cross model, the expenditure of households, firms, foreigners and the government on domestic goods and services is expressed as E= C + I + G + NX. Consumption (C) can further be expressed as C + b(Y − T ), where b is the marginal propensity to consume, Y is income and T is taxes.

Thus we have
E = C + b(Y − T )+ I + G + NX

If we draw a graph of these with expenditure on the vertical axis and production on the horizontal, equilibrium is represented as a 45-degree line (slope of 1) where Y=E. This expresses the accounting identities income = production and investment = savings.

The expenditure line, on the other hand, has a slope of less than one. This causes an intersection of the aggregate demand curve and the 45 degree line. This is equilibrium, where there is a balance between aggregate expenditures and aggregate production. At this point, there are no economy-wide surpluses or shortages because buyers buy all they want and sellers sell all they have. When actual GDP is increases above the ...

Solution Summary

Economic effects of Obama's stimulus package