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Question 1
Use the AS/AD framework to show the separate effects on GDP, inflation and public sector borrowing on any single national advanced economy of:
a. an increase in public infrastructure spending
b. an increase in the rate of tax on profits
c. a slowdown in the GDP growth of less developed economies.
(Make sure that you include clear and appropriate diagrams for this question).

Answer a. an increase in public infrastructure spending

An increase in public infrastructure spending is part of a fiscal policy in which the government needs to fund by borrowing from the private sector. The Government finances its spending issuing bonds which compete with other private bonds. An excess supply of bonds causes bond prices to fall and interest rate to rise. So in the IS/LM the IS curve shifts up, and GDP will go up because of the extra demand for goods and services. This is reflected in the AD-AS framework in which a government spending increase leads to an increase of AD (AD1 ( AD2) and this is reflected in an increase of level of output from Y1 to Y2 and a price level that increases (P1 ( P2). In this case the stimulus is intensive and it leads to get an aggregate demand which exceeds the full capacity national output. There is an excess of demand for good and services and a possible shortage of input resources. In the meanwhile there will be a derived demand for labour which will lower the unemployment rate, increasing labour costs and indirectly prices. So (P2, Y2) is our short term equilibrium position. In the long run since the expected price level P1 is smaller than the actual price level P2 then the nominal wage rate increases and this leads to a further increase of the price level (P3), real money supply decreases and we assist to a reduction in the short term aggregate supply (SRAS1 ( SRAS2) and an