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In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-runincrease in investment? Explain.a. When the investment accelerator is large or when it is small?b. When the interest sensitivity of investment is large or when it is small?
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Chapter 34
The Influence of Monetary and Fiscal Policy on Aggregate Demand
The Real Economy in the Long Run
Money and Prices in the Long Run
Short-Run Economic Fluctuations
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question 10 asks in which of the following circumstances is expansionary fiscal policy more likely to lead to a short run increase investment hard day when investment accelerator is large or when it is small? Well, to answer this question, first of all, when he's remember what the investment accelerator actually is in very simple terms that can be defined as the positive feedback from higher levels of the man to investment and to make the statement that being more incised, we can't express it. I can't express this relationship quantitatively using this very simple linear equation. Delta. I equals new times Delta y here Delta. I denotes the changed in investment. Have eyes investment Delta wide notice a change in a great demand and knew the Greek letter new sense for our investments the Raider, which is greater or equal to zero. Clearly, this relationship is denotes a positive relationship between the two variables, so we can conclude that expansionary fiscal policy is more likely to lead to a short run increase investment if the investments in the Raider is large, right? We want new to be asla. RJ is possible for the effect to be amplified. So with large investments of the Raider means that increasing out but caused by expansion official policy will induce it large increase investment. And in fact, we thought it'd large accelerator investment might actually decline because the increase in aggregate demand will raise interest rate. So we have to be very cautious about that. Part. B off the question asked us to compare what happens when the interest rate sensitivity of investment is large versus when it is small Again, we shall remember what the interest sensitivity stands for in very simple terms that can be defined as the degree to which firms adjust investment spending relative to the interest rate and to make this reaping what more clear we will employees. Simple linear equation, which reads captive I equals kind of vibe are minus sita times. Interest rates are here once again, couple idee notes in level of investment. I bar is think about it as a fixed level of investment or an ex sergeants level of investment. The Greek letter eat a sense for our interest since is everything which is between zero and one in ours are, as always, our interest rate so we can see there's a negative relationship between the two. And in fact, the interest sensitivity either which is negative or maybe enters with a minus sign also governs the slope off the agri demand curve, which, as you remember is is negative. So we can very easily conclude that expansionary fiscal policy is more likely to lead to a short on increase investment if the interest sensitivity of investment is actually small. Yeah, we have and negative relationship. So we won't need it to be as close to zero as possible. Because fiscal policy increases a great demand, thus increasing one of demand and the interest rate, the greater the sensitive of his best men to the interest rate, the greater the decline in investment will be which will offset the positive accelerator.
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