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Economics 2152A/B
Jennifer Mori

THE EXPERIMENTS Chapter 11 part IINow that we have two markets built we can do some experiments to see what effect a change in an exogenous variable will have on the endogenous variables in our model We will do four such experimentsExperiment 1A change in temporary government spendingSuppose the government increases spending in the current period Economic agents will realize that this means an increase in their taxes and thus a DECREASE in their LIFETIME WEALTH They perceive this change to be temporary in the sense that it occurs only in the current period therefore they will react by increasing their labour supply However this response will not be as strong as the response to a tax change that was perceived to occur over their entire lifetimeSTEP 1 Given r the labour supply curve shifts out due to a pure income effect At the prevailing interest rate this also causes the output supply curve to shiftStep 2 What about DemandRemember that the demand equation is YC rI rG and G has increased at the prevailing interest rate r Thus the output demand curve also shifts outthis causes the interest rate to rise See diagramStep 3Due to the intertemporal effect of the now higher interest rate the LABOUR SUPPLY curve shifts out again
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