Answer to Question #118263 in Economics for michael

Question

Examine the effect of an expansionary fiscal policy and highlight its effectiveness in the
economy within the Keynesian Cross-Model. [11 marks]
b) Outline two shortcomings of the model in a). [4 marks]

Answer 1

a) Expansionary fiscal policy increases aggregate demand through increase in government spending, decrease in taxes, or mix of these tools. As a result the price level and the real output increase.

b) Borrowing causes higher interest rates and financial crowding out. Keynesian economics advocated increasing a budget deficit in a recession.

If the government borrows to finance higher investment, the government is borrowing from the private sector and therefore, the private sector has fewer resources to finance private sector investment.