Exhibit 15-3 Aggregate demand and supply model Beginning at equilibrium E₁ in Exhibit 15-3, when the government increases spending or cuts taxes the economy will experience: A) an inflationary recession. B) stagflation. C) cost-push inflation. D) demand-pull inflation.

Question

Quizplus · Accepted Answer

When the government increases spending or cuts taxes, it will shift aggregate demand to the right from AD1 to AD2. This will increase both real GDP and the price level, leading to demand-pull inflation. There is no indication in Exhibit 15-3 that this will result in stagflation, as long as the aggregate supply curve is upwards sloping. Cost-push inflation is caused by increases in the costs of production, which is not directly related to government spending or taxation policy.

Exhibit 15-3 Aggregate Demand and Supply Model Beginning at Equilibrium