Consider an economy that is at general equilibrium. Suppose government increases its spending (G) temporarily, and finances this extra spending by borrowing from abroad.

a. Suppose people do not realize that government has to increase taxes in the future to paw back this borrowing. Using IS-LM framework show how output (Y) and real interest rate (r) change in the short run. How does the price level adjust? Where does the new generl equilibrium occur? (show short run equilibrium and general equilibrium points on your graph).

b. Suppose people do realize that pail mint has to increase taxes in the future to pay back this borrowing. Using IS-LM framework show how output (Y) awl real interest rate (r) change

in the short run. How does the price level adjust? Where does the new generl equilibrium occur? (Show short run equilibrium and general equilibrium points on your graph)

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a When government increases expenditure and people do not realize it then IS cur... View the full answer