The diagram below is for a closed economy which begins in long-run equilibrium at Y* and . FIGURE 31-3 Refer to Figure 31-3.Suppose the government implements an expansionary fiscal policy which increases the budget deficit.The initial effect of this policy is the opening of a(n)________ gap,and a new short-run equilibrium with a price level of ________ and real GDP of ________.

Question

The diagram below is for a closed economy which begins in long-run equilibrium at Y* and  .  FIGURE 31-3 Refer to Figure 31-3.Suppose the government implements an expansionary fiscal policy which increases the budget deficit.The initial effect of this policy is the opening of a(n)________ gap,and a new short-run equilibrium with a price level of ________ and real GDP of ________.

Quizplus · Accepted Answer

An expansionary fiscal policy will increase aggregate demand, leading to an increase in both the price level and real GDP in the short run. This will result in a new short-run equilibrium point at a higher price level and higher output level (Y₁). However, this new equilibrium point will also be to the right of the long-run aggregate supply curve, indicating that the economy is producing beyond its potential output level and putting inflationary pressure on prices, hence the price level will be higher (P₁). Therefore, the answer is D.

The Diagram Below Is for a Closed Economy Which Begins