When the SRAS curve shifts to the left, the economy faces lower output and higher prices, otherwise known as stagflation. If the government then enacts expansionary fiscal policy, what will be the effect on the economy?

Question

Quizplus · Accepted Answer

Expansionary fiscal policy involves increasing government spending and/or decreasing taxes, which leads to an increase in aggregate demand. Since the economy is already facing lower output and higher prices due to the leftward shift in the SRAS curve, an increase in aggregate demand will lead to a further increase in prices and some increase in output. However, the increase in output may not be significant enough to bring the economy back to its original level before the SRAS shift. Therefore, the most likely outcome is higher output and higher prices.

When the SRAS Curve Shifts to the Left, the Economy