AD1 is the initial aggregate demand curve and AS is the aggregate supply curve f

Question

AD1 is the initial aggregate demand curve and AS is the aggregate supply curve for an economy. Then the government pursues an expansionary fiscal policy action. AD2 shows the initial increase in aggregate demand and AD3 shows the final increase in spending after the fiscal policy action has worked its way through the economy (by means of the multiplier process).
Assume that the government increases spending to stimulate the economy. How large is the initial spending increase?
(ex: if your answer is $20 billion, then enter: 20)

A) Less than $5 billion
B) $5 billion
C) $20 billion
D) $25 billion

Explanation / Answer

Option (B).

Initial spending increase as result of government spending increase is reflected in the movement from AD1 to AD2 (Movement from AD2 to AD3 reflects overall increase in spending as result from multiplier effect, which is not the initial increase).

So initial incraese = $(414 - 409) = $5 billion

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