Econ 4th Edition by William McEachern

Exercise 6

FISCAL POLICY WITH AN EXPANSIONARY GAP Using the aggregate demand-aggregate supply model, illustrate an economy with an expansionary gap. If the government is to close the gap by changing government purchases, should it increase or decrease those purchases? In the long run, what happens to the level of real GDP as a result of government intervention? What happens to the price level? Illustrate this on an AD-AS diagram, assuming that the government changes its purchases by exactly the amount necessary to close the gap.