uppose a country is in the midst of a serious recession with high unemployment a
ID: 1190706 • Letter: U
Question
uppose a country is in the midst of a serious recession with high unemployment and large government deficits. The president suggests that in times like this the government has the obligation to “tighten its belt” and cut spending since so many families around the country have to do the same thing. In this case, a decrease in government spending will:
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Explanation / Answer
1. Push AD to the right and increase output.- False
2. increase the price level and costs.- False, an increase in government spending increases the aggregate demand, therby in increasing the price levels.
3. eventually cause a leftward shift of SRAS.- True.
4. push AD to the left and decrease output.- This is true because, aggregate demand is comprised of C(Y - T) + I(r) + G + NX(e) = Y. Thus, a decrease in any one of these terms will lead to a shift in the aggregate demand curve to the left, where C(Y - T) is disposable income, I(r) is Interest rates, G is government spending and NX(e) is Net income from exports.
5. decrease the price level and costs.- True, a reduction in government purchases would reduce aggregate demand. The aggregate demand curve shifts to the left, putting pressure on both the price level and real GDP to fall.
6. eventually cause a rightward shift of SRAS- False. A decreased government spending causes the SRAS to shift leftward
7. eventually cause a rightward shift of LRAS. False. A decreased government spending causes the SRAS to shift
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