Is expansionary fiscal policy more likely to lead to a short-run increase in investment a. when the investment accelerator is large or when it is small? Explain. b. when the interest sensitivity of investment is large or when it is small? Explain.

When discussing the mechanics of an economy, the investment accelerator plays a crucial role in magnifying the effects of changes in the overall economic activity. It can be thought of as a multiplier effect; when the economy grows, the investment tends to increase more than proportionately if the accelerator is large.

For instance, imagine an economy where demand for products begins to rise. If the investment accelerator is large, companies will aggressively invest in new equipment or facilities to keep up with the increased demand, leading to an even greater boost in economic activity. This can happen because of improved business confidence and expectations of higher future profits. However, if the accelerator is small, firms might be less inclined to expand their investment, resulting in a muted response to growth in output or GDP.

The concept of interest sensitivity of investment is pivotal when analyzing how businesses make investment decisions. Interest rates essentially represent the cost of borrowing money, and when these rates are low, companies can more affordably finance their expansion initiatives.

However, the relationship is not always straightforward. Some investments are incredibly sensitive to interest rates, meaning even small fluctuations can lead to significant changes in the amount businesses are willing to invest. Industries with large capital requirements, such as manufacturing, tend to be more affected by interest rate changes. On the other end of the spectrum, if investment is less interest-sensitive, businesses may continue their investment plans regardless of slight interest rate increases. Therefore, in the context of expansionary fiscal policy, if the interest sensitivity is low, the increased spending will more likely lead to increased investment, as the deterrent effect of potentially higher interest rates will be weaker.

Aggregate demand represents the total demand for all goods and services in an economy and is a fundamental concept in macroeconomics. It consists of consumption by households, investment by businesses, government spending, and net exports.

Expansionary fiscal policy aims to boost aggregate demand directly through increased government spending or indirectly via tax reductions. An increase in government spending injects additional income into the economy, which can then lead to more consumption and higher demand for goods and services. As a result, firms anticipate more sales and profits, which may prompt them to invest more in order to expand their production capacities. This connection between fiscal policy and aggregate demand highlights why government decisions are so influential in the economic cycle.

Government spending is a powerful tool for influencing the economy. When governments choose to increase their expenditure, they can initiate a cycle of economic growth by directly purchasing goods and services or by funding infrastructural projects. This can also lead to increased private investment as a reaction to the government's stimulus.

In the short run, such fiscal stimulus often leads to higher levels of investment by the private sector. This happens because businesses expect the government spending to result in increased demand for their products. Additionally, infrastructure improvements can lower operating costs for private enterprises, making investment projects more attractive. Understanding this dynamic is essential when considering the broader implications of fiscal policy on an economy's investment levels.