Question

1. The hypothetical information in the following table shows what the values for real GDP and the price level will be in 2015 if the government does not use fiscal policy :

Year	Potential GDP	Real GDP	Price Level
2014	$1.50 trillion	$1.50 trillion	110.0
2015	$1.54 trillion	$1.50 trillion	111.5

1. Draw an aggregate demand and supply graph to illustrate your answer. Be sure that your graph contains the LAS curves for 2014 and 2015; SAS curves for 2014 and 2015; an AD curve for 2014 and 2015, with and without fiscal policy action; and equilibrium real GDP and the price level in 2019, with and without fiscal policy.

Answer 1

Economy is at its natural level in 2014 where its actual GDP = potential GDP.

In 2014:

In 2015 (with no government action): If government takes no policy action, supply curve will shift to its right because nominal wages fall due to rise in unemployment which reduces cost of production for producers. Unemployment arises when economy is facing recession. Fall in cost of production shift aggregate supply curve to its right from AS to AS1. It reduce price and take output to its natural level.

In 2015 (with government policy): Government adopts expansionary fiscal policy to vanish recessionary gap in which they raise government spending and reduce tax such that people have more money to spend on goods and services which raise aggregate demand in the economy. It will shift demand curve to its right which raise price level and take economy to its natural level.