Download Answers to pause for thought questions

Chapter 14
Answers to pause for thought questions
p337
Show the effect of an increase in government expenditure by using the 45 line
diagram.
The effect is to shift the expenditure function upwards by an amount equal to the
increase in government expenditure. The result can be read off as an increase in
equilibrium GDP.
p339
Give other examples of random shocks.
A substantial increase in the world price of oil (as occurred in mid 2004). The
Asian currency crisis of 1997. A severe drought.
p348 
Do you agree that ‘ever more rapid financial flows across the world that are
unpredictable and uncertain’ make Keynesian discretionary fiscal (and monetary)
policy less suitable? Explain.
Discretionary fiscal policy can be undermined by international financial flows. For
example, if government expenditure is raised in order to stimulate the economy, the
resulting increase in demand for money will drive up the rate of interest. This will
lead to an inflow of finance from abroad and an appreciation of the rate of
exchange. This will reduce the demand for exports (an injection) and increase the
demand for imports (a withdrawal). The effect will therefore be to dampen the rise
in aggregate demand. Also, the unpredictability of international financial flows
makes the effects of fiscal (and monetary policy) changes less predictable.
Note that if there had been a policy of maintaining interest rates at the
original level, and thus increasing money supply in line with the extra demand for
money, then the above effects would not have occurred. What this means is that if
fiscal policy is to be effective, it must be backed up by monetary policy.
p352
If there were a gradual increase in the saving rate over time, would this lead to
sustained economic growth even without technological progress?
Yes, but the rate of economic growth would gradually slow down, given that the Y
curve gets less and less steep. If, however, the extra saving were invested in
research and development, with the result that the Y curve shifted upwards, this
would allow a higher output to result from the extra saving and hence a faster rate
of economic growth as saving increased over time.