(Figure: Aggregate Demand and Fiscal Policy) Figure: Aggregate Demand and Fiscal Policy Assume that the government of an economy in recession at Point Y in the diagram is aware of the expenditure multiplier when it formulates policy decisions. If it chooses to increase government expenditures by 4 percent, it should expect

Question

(Figure: Aggregate Demand and Fiscal Policy) Figure: Aggregate Demand and Fiscal Policy  Assume that the government of an economy in recession at Point Y in the diagram is aware of the expenditure multiplier when it formulates policy decisions. If it chooses to increase government expenditures by 4 percent, it should expect

Quizplus · Accepted Answer

According to the Keynesian expenditure multiplier, an increase in government expenditures will increase aggregate demand by a multiple of the initial increase. In this case, an increase in government expenditures of 4 percent will increase aggregate demand by a multiple of the initial increase, which is shown by the upward shift in the AD curve from AD1 to AD2. The new equilibrium level of output and price level will be at Point X. Therefore, the economy should expect to move at least to Point X.