Suppose an economy experiences a decrease in investment expenditure. a) Show graphically using AD-AS model how...

Suppose an economy experiences a decrease in investment expenditure. a) Show graphically using AD-AS model how the price level and output are affected in the short-run. b) Can the government use fiscal policy to offset the effects on price level and output, explain?

Expert Solution

A) decrease in investment expenditure will decrease aggregate demand. This shift the aggregate demand curve to the left. The price level and output level both are reduced in the short run. This is shown below

B) fiscal expansion is required in order to increase the price level in output to their initial levels. In this policy the government will increase its expenditure and / or it will reduce taxes in order to boost consumption and investment. This is going to increase aggregate demand and shift the aggregate demand curve to the right. Both the price level and the real GDP are now increased and return to their initial levels

Rahul Sunny answered 2 years ago

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