If the economy is at full employment, increases in government spending

Question

Quizplus · Accepted Answer

When an economy is already at full employment, any increase in government spending would increase aggregate demand, but the economy is already producing at its maximum potential output, therefore the demand-pull inflation arises. Prices increase as there is no more output to produce and handle the excess demand. As a result, the increase in government spending is primarily absorbed by price increases.

If the Economy Is at Full Employment, Increases in Government