Answer to Question #246668 in Macroeconomics for shaesha

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

Solution:

a.). When the government step in and spend, this will result in increased aggregate demand, which then will increase the real output or GDP resulting in an increase in prices.

b.). A cut in spending by European firms, will affect the economy negatively. It will result to a deficit in the economy, reduce investment opportunities, and decrease consumer’s disposable income. The aggregate demand as such will decrease and shift to the left, resulting to a decrease in Real GDP output and a decrease in the price levels.

This has been displayed by the below graph: