Question

Problem 12-10: Opportunity Cost of Spending Refer to the figure below Publlo sector Output (unts per year Private sector Output (units per year) The consumption possibility paint foreign sources. "represents the consumption bundle where the additiona/output imports, is financed by 1. What is the opportunity cost of increasing government spending from 9 to 92 (a) No external financing funds are not from foreign sources is available OO- 00-12 Ohh2 No opportunity cost Complete external financing is available in the short-sun 00-12 No opportunity cost Ohh2 2. the economy isins recession zero. Otis operating inside the production possibles curve, and the opportunity cost of delict spending The economy suffers from structural unemployment, which can be sleeted by debt refinancing O Larger deficits will decrease the national debt Delict spending will not increase the size of the debt because interest rates will be failing

Answer 1

1.a) Answer : h1 -h2

When governement spending increases from g1 to g2, private spending falls from h1 to h2. There is crowding out effect.

b) Answer : no opportunity cost

When government spending increases from g1 to g2 through external financing, private spending does not fall and so there is no opportunity cost.

2. If the economy is in a recession, it is operating inside the production possibilities curve and the opportunity cost of deficit spending is zero.

When it is in recession, the is deficiency in aggregate demand and supply. There is no sufficient spending. Hence, it operates inside the production possibility curve.