Figure: AS/AD Assume that an economy begins initially at Point 1 in the figure. An increase in government spending accompanied by intertemporal substitution would move the economy to Point _____.

Question

Figure: AS/AD  Assume that an economy begins initially at Point 1 in the figure. An increase in government spending accompanied by intertemporal substitution would move the economy to Point _____.

Quizplus · Accepted Answer

An increase in government spending (shifts AD to the right) accompanied by intertemporal substitution (a temporary increase in consumption) would result in a movement along the SRAS curve from Point 1 to the right, reaching Point 3 as the new equilibrium. This is because the temporary increase in consumption in the short-run would cause a temporary increase in output and prices, which would result in a higher quantity supplied (movement along the SRAS curve) until the economy reaches a new equilibrium at Point 3 with higher output and prices.

Figure: AS/AD Assume That an Economy Begins Initially at Point