Question

1. True or False: Expansionary fiscal policy is more likely to lead to a short-run increase in investment when the investment accelerator is large than when it is small.

2. True or False: Expansionary fiscal policy is more likely to lead to a short-run increase in investment when the interest rate sensitivity of investment is large than when it is small.

Answer 1

a. Expansionary fiscal policy is more likely to lead to a short-run increase in investment if the investment accelerator is large.

True

A large investment accelerator means that the increase in output caused by expansionary fiscal policy will induce a large increase in investment. Without a large accelerator, investment might decline because the increase in aggregate demand will raise the interest rate.

b. Expansionary fiscal policy is more likely to lead to a short-run increase in investment if the interest sensitivity of investment is large.

False

Because fiscal policy increases aggregate demand, thus increasing money demand and the interest rate, the greater the sensitivity of investment to the interest rate the greater the decline in investment will be, which will offset the positive accelerator effect.