Suppose that real GDP equals potential GDP, but the government believes that the economy is in a below full- employment equilibrium. As a result, the government increases its expenditure on goods and services. In response to the government's fiscal policy,
A) an equilibrium with real GDP less than potential GDP will occur.
B) aggregate demand will increase.
C) potential GDP decreases.
D) None of the above answers is correct..

Question

Quizplus · Accepted Answer

When the government increases its expenditure on goods and services, it leads to an increase in aggregate demand. As a result, there will be upward pressure on the price level and output. The increase in aggregate demand will move the economy towards a new equilibrium with a higher level of real GDP, but it may not necessarily be at potential GDP. Therefore, option A is incorrect. Furthermore, the increase in government expenditure does not affect potential GDP, which is determined by the economy's structural factors such as technology, labor force, and capital stock. Therefore, option C is also incorrect.

Suppose That Real GDP Equals Potential GDP, but the Government