Refer to the graph below.Assume that the economy is in initial equilibrium where AS₁ intersects AD₁.Then a supply shock occurs that shifts AS₁ to AS₂.If the government counters with an expansionary fiscal policy that shifts AD₁ to AD₂,then it is most likely that: A) AD₂ will shift to AD₁. B) AS₂ will shift to AS₁. C) AS₂ will shift to AS₃. D) AS₂ will shift to AS₃ and AD₂ will shift to AD₁.

Question

Quizplus · Accepted Answer

When the supply shock occurs, the aggregate supply curve shifts from AS₁ to AS₂, causing the price level to increase and output to decrease. The expansionary fiscal policy implemented by the government shifts the aggregate demand curve from AD₁ to AD₂, causing both the price level and output to increase. Therefore, the economy moves to a new equilibrium at the intersection of AS₂ and AD₂, where the price level is higher than the initial equilibrium but output is uncertain. The answer is C because there is no reason to assume that any further shifts in the aggregate demand curve will occur.

Refer to the Graph Below