ECON 1110 Lecture Notes - Lecture 13: Investment Goods, Potential Output, Output Gap

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Elements of fiscal policy that reduce the responsiveness of real gdp to changes in autonomous expenditures. Recall: y = [1/(1-b (1-t)+m)] [c0 + i0 + g0 + x0] Decrease in t = increase in the simple multiplier = response of changes in aggregate expenditures to autonomous expenditures is higher. Increase in government spending can leave y* unchanged. Begin at y: increase in g, increase in ae, ad shifts to the right, higher prices and output, increase in input prices, higher cost of production, as curve shifts to the left, back at y* Increase in g has crowded out private expenditures. Even if an increase in government purchases leaves the current level of potential output unchanged, the crowding out of private investment may reduce future growth rate of potential output. Begin at y: increase in g, public infrastructure that increases the productivity of firms, increase in y* The negative effects from crowding out of private investment will be reduced.

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