Use the following to answer questions : Figure: Fiscal Policy with a Fixed Money Supply -(Figure: Fiscal Policy with a Fixed Money Supply) Look at the figure Fiscal Policy with a Fixed Money Supply. Assume that this economy is at E₁. Now government deficit spending is increased, but the Federal Reserve does NOT expand the money supply. According to this model: A)real GDP will expand just as much as if the Federal Reserve had expanded the money supply. B)real GDP will decrease because the Federal Reserve did not expand the money supply. C)real GDP will expand, but not as much as if the Federal Reserve had expanded the money supply. D)interest rates will decrease.

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According to the figure, when government deficit spending is increased without expanding the money supply, the aggregate demand curve will shift to the right from AD1 to AD2, which will lead to an increase in both real GDP and price level. However, because the money supply is fixed, the increase in price level will reduce the real value of money, leading to a decrease in consumption and investment spending. Therefore, real GDP will expand, but not as much as if the Federal Reserve had expanded the money supply. Interest rates are not affected by this change in fiscal policy.

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