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2008 Form B

2008 Form B. By Tadeh Mirzakhanian. 1. Assume that the economy of Country Z is operating on the upward-sloping portion of its short-run aggregate supply curve. Assume that the government increases spending.

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2008 Form B

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  1. 2008 Form B By TadehMirzakhanian

  2. 1. Assume that the economy of Country Z is operating on the upward-sloping portion of its short-run aggregate supply curve. Assume that the government increases spending.

  3. (a) How will the increase in government expenditures affect each of the following in the short run? (i) Aggregate demand (ii) Short-run aggregate supply

  4. Government spending has nothing to do with the aggregate supply in the short run.The short-run aggregate supply is not affected. Government spending is one of the shifters for aggregate demand.An increase in government spending = increase in aggregate demand

  5. (b) Using a correctly labeled graph of aggregate demand and aggregate supply, show the effect of the increase in government expenditures on real output and the price level.

  6. Make sure you show and label the increase in output and the price level.

  7. (c) Assume that the government funded this increase in expenditure by borrowing from the public. Using a correctly labeled graph of the loanable-funds market, show the effect of the increase in government borrowing on the real interest rate.

  8. A rightward shift of the demand curve, so eventually the interest rate will rise.

  9. You could also show that the supply curve shifts to the left

  10. (d) Given the change in the real interest rate in part (c), what will be the effect on each of the following on the foreign exchange market? i. Supply of country Z’s currency. Explain ii. The value of country z’s currency.

  11. i.The supply of country z’s currency will decrease. Why?Here’s why: the higher interest rate reduces the outflow of funds to countries that now have a relatively lower interest rate.

  12. ii.So what is going to happen if your country’s supply for currency decreases?Your currency increases in value.The fancier way to say this is: it appreciates 

  13. (e) Given your answer in part (d) (ii), what will be the effect of the change in the value of Country Z’s currency on Country Z’s exports? Explain.

  14. Country z’s exports will decrease. But why?Here’s why: when your money appreciates, then the goods in your country will be relatively more expensive than other countries’. So why would anybody want to buy your country’s products?

  15. Finished

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