Answer to Question #279455 in Macroeconomics for bobby 57

Question

In the real business cycle model, suppose the government spending increases temporarily.

1. Determine the effect on labour market, holding the interest rate constant? [5 pts]

2. Explain what impact this temporary increase in government spending has in the goods market, holding the interest rate constant? Illustrate with graphs. [10 pts]

3. Suppose that the interest rate increases in response to this temporary increase in government spending. How will it affect the labour market and the goods market? Illustrate with graphs. [5 pts]

4. Argue that the price level could go up or down. Specify the conditions under which the price level goes up. Illustrate graphically. [ 6pts]

5. Determine whether investment and average labor productivity increases or decreases. [2 pts]

6. Are these predictions consistent with the business cycle facts? (Draw a table) [7 pts]

Answer 1

1.     Increased government spending leads to increased economic investment. This leads to an increase in labor demand and, as a result, an increase in labor wages. Because the interest rate in the business cycle model is constant, as well as the reality that government spending is only temporary, the labor supply must increase.

2.     Although the interest rate remains constant, the impact of transitory increases in government spending will enhance labor supply, which will benefit the products market. The following graph demonstrates the same:

3.     The labor market will also increase if the interest rate is increase as it is directly proportional to the interest rate. The graph depicts below the same: Rate of interest Real aggregate supply Real aggregate demand Income Real Business-cycle Model.

4.     Because interest rates and price levels are inversely related, the price level rises when the interest rate falls. The graph below illustrates the same: Interest rate Amount of real aggregate demand AD (Aggregate Supply) Earnings from AD: Fiscal Policy's Impact on the Real-Business Environment.

5.     Investment and the average labor productivity will increase when the rate of interest increase as it is directly proportional to it or a vice-a-versa.

6.     It totally depend upon the interest rate as the business cycle facts predictions depend upon the labor productivity and the interest rate.