Question

If governments were to increase spending, determine the effect on RGDP, price levels, and AD. By increasing spending, do you believe government is trying to slow down or speed up the economy? Why? I When economic growth occurs, what happens to LRAS and SRAS? What happens to price levels and RGDP

Answer 1

With an increase in government spending, real GDP (RGDP) increases, price level increases with a rise in inflation and there is a rightward shift in the aggregate demand. The government spending, works as a stimulus to the economy and it has the spending multiplier effect that depends upon the size of marginal propensity to consume.

By increasing the spending, the government is trying to speed up the economy, because spending creates demand that leads firms to increase supply and create new jobs. It reduces unemployment, increases consumption and the economy expands. Government does to create employment, increase real GDP and build confidence among the people to increase their consumption level.

With economic growth,  LRAS does not change. SRAS will also not change, unless there is a supply side fiscal policy to encourage the firms. Further, if economic growth creates an inflationary gap and demand pull inflation, then SRAS will shift to the left to achieve long run equilibrium. Price level and RGDP increase with economic growth.