Answer to Question #144795 in Accounting for Anushun Jayadharman

Question

Illustrate a permanent decrease in government spending
(let’s say infrastructure spending freeze) implemented in 2022. For simplicity,
assume there are no time lags.
a). (2 point): To illustrate that shock, use AE/PC Model (carefully labeled!!)
without time lags (use the AE and PC graphs similarly to the textbook, place PC
graph below AE graph). For your analysis, choose as a starting point (marked A)
an economy operating at potential GDP (Y=Y*) and at its inflation target (

Answer 1

A permanent decrease in government spending can be shown as a decrease in aggregate expenditure (AE). In this case the expansionary monetary policy will be implemented by the central bank to stimulate the increase in AE to reach the previous price level and potential income level (Y = Y*) .