If there are perfectly flexible prices and the economy is operating at Y(N),then an increase in government expenditures
A)will increase real GDP and the price level.
B)will increase nominal GDP and the raise price level.
C)will not lead to complete real crowding out.
D)will lead to complete nominal crowding out and have the price level unchanged.

Question

Quizplus · Accepted Answer

In the short run, an increase in government expenditures will increase aggregate demand, shifting the AD curve to the right. This will initially result in an increase in both real GDP and the price level. Since prices are assumed to be flexible, any increase in aggregate demand will be reflected in an equivalent increase in nominal GDP. However, over time, the higher price level will lead to a decrease in the real value of money, causing interest rates to rise and investment spending to fall. This will begin the process of crowding out, but it will not be complete since prices are flexible and will adjust to the increase in aggregate demand. Therefore, nominal GDP will continue to rise, but not as much as it would without the crowding out effect.

If There Are Perfectly Flexible Prices and the Economy Is