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a) Economists often argue that a temporary increase in government purchases -say for military purposes-will crowd out private investment. Use the saving-investment diagram to illustrate this point, explaining why the curve(s) shift. Does it matter whether the temporary increase in military spending is funded by taxes or by borrowing?
b) Alternatively, suppose that the temporary increase in government purchases is for infrastructure (roads, sewers, bridges, etc) rather than for military purposes. The government spending on infrastructure makes private investment more productive, increasing the expected future MPK at each level of capital stock. Use the saving-investment diagram to analyze the effects of government infrastructure spending on current consumption, national saving, investment, and the real interest rate. Does investment by private firms get crowded out by this kind of government investment? If not, what kind of spending, if any, does get crowded out? (For simplicity assume that households do not expect a change in their future income.)
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