Final answer:
Decreasing government expenditures leads to a downward shift in the Aggregate Expenditures schedule, causing real GDP to decrease and interest rates to potentially fall. This fiscal contraction results in increased unemployment and lower future GDP, but lower interest rates might encourage consumption and investment to some degree.
Step-by-step explanation:
When the U.S. government decreases expenditures (G↓), there is an initial shock to the economy as the Aggregate Expenditures schedule shifts down. This shift indicates a reduction in total spending within the economy, which leads to a decrease in aggregate demand.
The immediate effect on real GDP (Y) is a decrease as lower government spending reduces the overall demand for goods and services. This decrease in spending affects the demand for real balances (Mᵃ), which will shift left as the need for transactions decreases due to lower spending and economic activity.
The interest rate (r) is likely to fall as the demand for loans decreases when both consumption (C) and gross investment (I) decline. The lower interest rate should, in theory, stimulate investment and consumption but may not be enough to offset the initial decrease in government spending.
Given these dynamics, we can expect the following changes in the economy compared to the original equilibrium:
- Real GDP (Y): Decrease
- Employment: Decrease
- Unemployment: Increase
- The unemployment rate: Increase
- Interest rate (r): Decrease
- Consumption (C): Decrease or potentially remain the same
- Gross Investment (I): Increase or potentially remain the same
- Future capital (Kᵌᵕᵖᵔₜ): Decrease
- Future real GDP (Yᵌᵕᵖᵔₜ): Decrease
- Consumer Confidence (CC): Decrease
Overall, a government expenditure cut leads to a contraction in economic activity, raising unemployment and lowering GDP, but may result in lower interest rates, which could influence consumption and investment decisions.