Consider the standard aggregate supply and demand model that is in long run equilibrium. Assume that the government has a balanced budget requirement wherein they must equate government spending and tax revenues each year. (That is, G = T and no deficits or surpluses are allowed) 

a. (1 pt.) There is a sudden increase in firm confidence in the economy. Which component of aggregate spending would be impacted by this change? 

b. (6 pts.) Show the effect of increasing firm confidence on the AD/AS model in the short run. What is the effect on unemployment and the price level? 

c. (3 pts.) If the government had a balanced budget prior to the increased firm confidence, does the government run a budget deficit or budget surplus after the shock? Briefly explain. 

d. (2 pts.) Following the increased firm confidence, how should the government adjust spending and taxes to achieve a balanced budget as required? 

e. (5 pts.) On a new graph, continuing from your graph in (b), draw the effect of the adjustments you describe in (d) on the AD/AS model in the short run. 

f. (3 pts.) Does the adjustment you describe in (d) that is required for the government to maintain a balanced budget produce a desirable effect on the economy in the short run? Explain. 

g. (5 pts.) Describe how the economy would self-adjust back to long run equilibrium following your graph from (e). Do not draw a graph here, just provide a clear explanation. 

Answer rating: 100% (QA)

a The component of aggregate spending impacted by an increase in firm confidence is investment I When firms are more confident about the economy they ... View the full answer