Answer to Question #226215 in Macroeconomics for Veyy

Question

With the aid of a diagram and using the Keynesian analysis , explain in detail how income and aggregate spending are affected by the following :
(a) ' government should step in and spend'
(b) A cut in spending by European firms

Answer 1

In the Keynesian model, aggregate expenditure is the total of consumption (C), investment (I), government expenditure (G), and net exports (X-M). When the government and businesses cut spending, two components of AE, G and I, decrease, causing the AE curve to move downward from AE' to AE'. This new AE' curve meets the AS curve at E', implying that GDP has decreased from 0M to 0M'.