Question

QUESTION 3

3.1. Use a diagram to explain how a decrease in government spending will affect the level of income in the Keynesian model. (Explanation)

3.2. Use a diagram to explain how an increase in taxes will affect the level of income in the Keynesian model. (Explanation)

3.3. South Africa experienced a severe decline in real gross domestic production during the last quarter of 2008 and the two quarters of the first half of 2009. Use an AD-AS model to illustrate and explain the policies that could be used to resolve this situation. (Explanation)

Answer 1

Solution 3.1

In keynesian model, decrease in government spending will cause limited supply of money in market and taxes will be generally higher causing lower disposables incones and hence aggregate demand falls and hence do prices fall with decrease in real GDP.

Solution 3.2

An increase inntaxes will reduce disposable incomes and people will save more and spend less. This will cause aggregate demand and consumption to fall and hence causing prices and real GDP to fall.

Solution 3.3

Since Southafrica declined its GDP it needs to boost GDP using an expansionary monetary policy or expansionary fiscal policy. This will increase money supply either through cut in interest rates, cut in taxes or increase in Government spending.

All this will increase disposable incomes and increasing aggregate demand. This will thus cause real GDP to return to mormality.