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In: Economics

Please use the IS-LM diagram and AD-AS diagram to describe the short run and long run...

Please use the IS-LM diagram and AD-AS diagram to describe the short run and long run effect of positive shock of government purchases.

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Expert Solution

Aggregate demand = Consumption + Investment + Government spending + Exports - Imports

Rise in government spending will raise aggregate demand in an economy in short run which will shift AD curve to its right from AD to AD1 which raise price level from P to P1 and output level from Y to Y1.

Increase in aggregate demand will shift IS curve to its right from IS to IS1 which will raise rate of interest from "i" to "i1" and raise output level from Y to Y1.

In long run, producers will raise their aggregate supply of goods to complete demand which rises in short run. It will shift supply curve to its right from AS to AS1. It will reduce price to its initial level of P and raise output level further.

In long run, Fed will increase money supply to induce producers to invest. It will lower rate of interest to its initial level and raise output level further.

Rahul Sunny answered 2 years ago
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