Question: Consider the following linear version of the AA-DD model in the text: Consumption is given by C = (1 - s)Y and the current account

Consider the following linear version of the AA-DD model in the text: Consumption is given by C = (1 - s)Y and the current account balance is given by CA = aE - mY. (In macroeconomics textbooks, s is sometimes referred to as the marginal propensity to save and m is called the marginal propensity to import.) Then the condition of equilibrium in the goods market is Y = C + I + G + CA = (1 - s)Y + I + G + aE - mY. We will write the condition of money market equilibrium as Ms>P = bY - dR. On the assumption that the central bank can hold both the interest rate R and the exchange rate E constant, and assuming that investment I also is constant, what is the effect of an increase in government spending G on output Y? (This number is often called the open-economy government spending multiplier, but as you can see it is relevant only under strict conditions.) Explain your result intuitively.

Step by Step Solution

3.45 Rating (171 Votes )

There are 3 Steps involved in it

1 Expert Approved Answer
Step: 1 Unlock

Openeconomy government spending multiplier tends to raise national output y by an increase in govern... View full answer

blur-text-image
Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock
Step: 3 Unlock

Document Format (1 attachment)

Word file Icon

1253-B-C-F-I-C-F(562).docx

120 KBs Word File

Students Have Also Explored These Related Corporate Finance Questions!