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 would shift the AD curve to the right, causing an increase in output and price level. However, the intertemporal substitution effect would lead to an increase in savings and decrease in consumption, shifting the AD curve back to the left. Point 3 is the point where the AD curve after the intertemporal substitution effect intersects with the initial AS curve.

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