If the government increased its expenditures and reduced taxes, how would this policy affect the real output and the price level in the short run if the economy is:
1. experiencing 20% unemployment rate
2. experiencing mild recession
3. at the real output level
Increasing expenditures and reducing taxes are the tools used by the government to expand the economy. They are therefore collectively referred to as "expansionary fiscal policy."
Fiscal policy is an important tool for managing the economy because of its ability to affect the total amount of output produced?that is, gross domestic product. The first impact of a fiscal expansion is to raise the demand for goods and services. This greater demand leads to increases in both output and prices. The degree to which higher demand increases output and prices depends, in turn, on the state of the business cycle which can be represented by the shape of the supply curve.
The aggregate demand curve shifts to the right as the economy expands. When the aggregate demand curve shifts right, the quantity of output demanded for a given price level rises. Therefore, a shift of the aggregate demand curve to the right ...