“Please type, don't write (except drawing graph).” Suppose the government spending increases: B2a. What is its...

“Please type, don't write (except drawing graph).”

Suppose the government spending increases:

B2a. What is its effect on Aggregate Demand (AD) curve?

B2b.Draw a diagram, to illustrate its effect on price level and output in short run.

B2c. Explain your answer in words for question B2b.

B2d.Draw another diagram, to illustrate its effect on price level and output in both short run and long run.

B2e. Explain your answer in words for question B2d.

Solutions

Expert Solution

B2a. What is its effect on Aggregate Demand (AD) curve?

Increase in government spending shifts the aggregate demand curve to right thereby signifying rise in output level.

B2b.Draw a diagram, to illustrate its effect on price level and output in short run.

B2c. Explain your answer in words for question B2b.

Increase in government expenditure tends to shift AD to AD1. Since economy was below its potential level. Hence, when aggregate demand rises, economy or GDP moves towards the new equilibrium which is established at full potential level. there is marginal rise in price level. Thus, increase in Aggregate Demand is partly reflected on price level and partly reflected on output level.

B2d.Draw another diagram, to illustrate its effect on price level and output in both short run and long run.

B2e. Explain your answer in words for question B2d.

Diagram shows that in short run, When Aggregate demand shifts to right, there is rise in both output level and price level. Shifting of AD to AD1 increases output level.

But over the long run, When AD1 shifts to AD2, there is no rise in output level. Demand is fully reflected on rise in price level.

Rahul Sunny answered 1 year ago

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