Question

Use the Keynesian cross to predict the impact on equilibrium GDP of an increase in government purchases

Answer 1

Keynesian cross:

Aggregate expenditure= Consumption expenditure +Investment +Government expenditure(Purchase)

Equilibrium arises where :

Real GDP(Y)= Aggregate expenditure(AE)

In the graph below, AE is on Y axis and real GDP on X-axis. AE is the upward sloping curve and Y=AE is the 45 degree line.

E is the initial equilibrium where Y* is the equilibrium real GDP.

Now as the government purchases increases, it will cause rise AE which results in upward shift of AE curve from AE to AE'. This will cause new equilibrium at point E' where new equilibrium real GDP at Y**. Here we can observe Y*<Y**. So as government purchases increases, equilibrium real GDP also increases.

AE Y=AE AE' E' AE E 45 degree 0 Y* Y** Real GDP(Y)