Price level GDP deflator 2005 100 SolutionAnswer 10 a Accor

Solution

Answer : 10) a) According to the diagram, at point D the aggregate demand curve is AD₀ and the short run aggregate supply curve is SAS₁ . Now if the government increase expenditure then income for people increase which increase the aggregate demand and as a result, the aggregate demand curve shifts to rightward and becomes AD₁ on existing aggregate short run supply curve SAS₁ .

From the diagram it is clear that at point C, AD₁ = SAS₁ . Therefore, the economy moves to point C after increase in government expenditure.

b) In the given diagram, the potential GDP is $13 trillions as at this real GDP level AD = SAS = LAS. Now if the economy is at point B then contractionary fiscal policy shift the AD curve to leftward and becomes AD₀ on existing SAS₀ curve and thus the economy attain the potential GDP at point A. Therefore, here the contractonary fiscal policy is applicable to attain the potential GDP.

c) From the diagram it is clear that if the economy\'s current real GDP is in less than the potential GDP $13 trillions then the expansionary fiscal policy shift the aggregate demand curve AD₀ to rightward and become AD₁ . The AD₁ curve attains the potential GDP at point C and also increase the real GDP. Therefore, here the expansionary fiscal policy is applicable to increase the real GDP.