Figure: Aggregate Demand and Fiscal Policy Refer to the figure.Assume the government of an economy in recession at point Y in the diagram is aware of the expenditure multiplier when it formulates policy decisions.If it chooses to increase government spending growth by 4percentage points,it should expect the economy to:
A) move at least to point W.
B) move at least to point X.
C) move at least to point Z.
D) stay at point Y.

Question

Figure: Aggregate Demand and Fiscal Policy  Refer to the figure.Assume the government of an economy in recession at point Y in the diagram is aware of the expenditure multiplier when it formulates policy decisions.If it chooses to increase government spending growth by 4percentage points,it should expect the economy to:
A) move at least to point W. 
B) move at least to point X. 
C) move at least to point Z. 
D) stay at point Y.

Quizplus · Accepted Answer

If the government increases government spending growth, it will shift the aggregate demand curve to the right, which will increase real GDP and price level. However, the size of the shift depends on the expenditure multiplier. Since the economy is in a recession, the expenditure multiplier is likely to be higher than one, meaning that a $1 increase in government spending will lead to more than a $1 increase in real GDP. Therefore, a 4% increase in government spending growth should be enough to move the economy to point X, where output is at its potential level. Moving to point W or Z would require a larger increase in government spending or a combination of fiscal and monetary policies. However, these options are not among the answer choices.

Figure: Aggregate Demand and Fiscal Policy Refer to the Figure.Assume