Crowding out : Questioning expansionary fiscal policy On this graph, ADI represe
ID: 1168991 • Letter: C
Question
Crowding out : Questioning expansionary fiscal policy On this graph, ADI represents the initial aggregate demand curve in a hypothetical economy, and SRAS represents the initial aggregate supply curve. the economy's full empolymemt level of real GDP is $12 billion per year. The initial short-run equilibrium level of real GDP is and the intial short-run equilibrium price level is _. Suppose the government, seeking full empolyment, borrows money and increases its expenditures by the amount it belives necessary to close the output gap. According to keynesian economists, which curve is most likely to be the new aggregate demand curve on the graph? AD2 AD1 AD3 As a result, the equilibrium level of real GDP will be, and the equilibrium price level will be _. According to keynesian economists, which of the following is true for this case? real GDP does not increase; only the price level increases. The increase in deficit-financed government spending causes real GDP to increase, but not to the full employment level. The increase in deficit-financed government spending causes real DGP to increase to the full employment level. The increase in deficit-financed government spending has no impact on real GDP or the price level. This is example of_.Explanation / Answer
Initial short-run equilibrium level of real GDP is the real GDP on the horizontal axis corresponding to the intersection point of initial aggregate demand curve, AD1 and initial aggregate supply curve, SRAS which is $10 billion.
Initial short-run equilibrium price level is the price level on the vertical axis corresponding to the intersection point of initial aggregate demand curve, AD1 and initial aggregate supply curve, SRAS which is 100.
Thus, the initial short-run equilibrium level of real GDP is $10 billion and initial short-run equilibrium price level is 100.
Increased government expenditure aided by borrowings will bring an increase in aggregate demand due to multiplier effect and aggregate demand curve will shift rightwards from AD1 to AD3.
Thus, according to Keynesian economists the AD3 curve is the most likely to be the new aggregate demand curve on the graph.
New equilibrium level of real GDP is the real GDP on the horizontal axis corresponding to the intersection point of new aggregate demand curve, AD3 and initial aggregate supply curve, SRAS which is $12 billion.
New equilibrium price level is the price level on the vertical axis corresponding to the intersection point of new aggregate demand curve, AD3 and initial aggregate supply curve, SRAS which is 102.
Thus, the new equilibrium level of real GDP is $12 billion and new equilibrium price level is 102.
According to Keynesian economists, the increase in deficit financed spending will cause the real GDP to increase to its full employment level and in this way output gap gets eliminated.
Thus, correct option is 3.
The givcen case is an example of usage of expansionary fiscal policy to plug or eliminate output gap or recessionary gap.
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