The Sylvanian economy has been experiencing difficulties due to the COVID pandemic, and it is considering three possible strategies to boost aggregate demand: (1) sending cash payments directly to its citizens (i.e. each adult citizen would receive a check in the mail); (2) increasing unemployment insurance payments (i.e. each recipient of unemployment insurance would be eligible to receive a larger payment than usual); (3) hiring 1,000 new public school teachers

1. For each of these three items, specify (i) whether each would count as a change in taxes, a change in transfers, a change in government spending on goods and services, or none of the above, and (ii) which category of aggregate expenditure each item would primarily affect.
2. What is the value of the multiplier on changes in government spending on goods and services in Sylvania? What is the value of the multiplier on changes in taxes and transfers in Sylvania?

The president of Sylvania decides to go with option 3: hiring 1,000 public school teachers. In order to avoid dampening the effect of the new policy, it will be paid for with increased borrowing rather than an increase in taxes.

3. What impact will the decision to pay for the policy with borrowing rather than taxes have on the market for loanable funds? Specifically, what impact, if any, will it have on the loanable funds demand curve, the loanable funds supply curve and the equilibrium interest rate?
4. Will the change in the market for loanable funds you describe in part (g) diminish the effectiveness of the President’s proposed policy? If so, how significant do you think this diminishing effect will be? Explain your answer.

Answer rating: 100% (QA)

i We first categorize the government policies to boost aggregate demand under various categories as ... View the full answer