Question

using the classical model closed economy what are the effects on the variables below of a temporary increase in government spending.

--- Output

--- Real Interest

---Price level

--- Wage rate ( real )

-- Wage rate ( nominal)

Please draw the models to analyze and answer the scenario.

Answer 1

In a classical model of a closed economy, output is fixed at its long run level.

AD and LRAS determine the price level

Investment and vertical saving function determine the real rate of interest

As there is a temporary increase in government spending, AD demand increases as G is increased.

This reduces national saving and so saving curve shifts left

Real interest rate increases and this reduces investment

Eventually, rise in G reduces I by the same amount which means there is no final change in AD

Hence,

--- Output remains fixed

--- Real Interest rate rises.

---Price level rises

--- Wage rate ( real ) remains fixed

-- Wage rate ( nominal) rises to match price rise.