1. The size of the economy currently stands at US$10,000m, however unemployment is a major problem due to the downturn in the economy caused by the pandemic and a fall in export revenue of is two major exports - natural gas and oil. The unemployment rate has risen to 10% and the economy has been declining since 2014. The Minister of Finance has decided to implement a fiscal stimulus package worth $500m comprising mostly of higher government spending on infrastructure projects. The government plans to finance some of its expenditure by borrowing from domestic sources such as commercial banks. Currently the marginal propensity to consume (MPC) is 0.65, partly reflecting consumers’ willingness to save given the uncertainty in the economy. (i) What is the Keynesian prescription for a government that is managing an economy that is contracting and there is high unemployment? Mention one of the assumptions of Keynesian economics 5 marks

(ii) Draw a Keynesian cross showing the current equilibrium GDP at US$10,000m 5 marks
(iii) Calculate the Keynesian spending multiplier? 1 mark
(iv) Given the size of the multiplier and the size of the fiscal stimulus (higher government expenditure) what would be the actual change in gross domestic product? 2 marks

b) Draw a Keynesian cross showing the change in aggregate expenditure, the new equilibrium and the change in GDP as a result of the fiscal stimulus
10 marks
(ii) If the MPC is 0.80 and the government wanted to grow the economy to US$12,000m how much would the government need to spend to reach its GDP target? 5 marks

2) Classical economists are not supporters of higher government spending to alleviate unemployment and a recession. They believe that prices such as wages and interest rates need to adjust.
(i) State one assumption of classical economists 1 mark
(ii) Classical economists believes that higher government spending financed by domestic borrowing leaves aggregate demand unchanged because of the ‘crowding out effect’. Explain what is the ‘crowding out effect’ and use it to explain how higher government spending financed by domestic borrowing leaves GDP unchanged.
5 marks

(ii) If higher government spending was financed by higher taxes why would aggregate demand still remain unchanged according to classical economists?
2 marks
(iii) Keynesian economists focus on the demand side of the economy while classical economist focus on the supply side and are not proponents of increasing aggregate demand to increase GDP. What sort of investments classical economists recommend that would trigger long run economic growth? 3 marks