Question

4.The short-run effects of an increase in government purchases are that inflation will ____, and real GDP will ____.

Select one:

a. decrease; increase

b. increase; remain unchanged

c. remain unchanged; decrease

d. remain unchanged; increase

e. increase; increase

Answer 1

4.e. increase; increase

The short-run effects of an increase in government purchases are that inflation will increase, and real GDP will increase.

The aggregate demand(AD) in an economy is composed of aggregate consumption(C), aggregate private investment(I), government purchases of goods and services(G),and net exports(X-M). The change in any of these components changes the AD and thus shifts the AD curve. The increase in government purchases in short-run, increases the AD, and it leads to demand-pull inflation.As a result the price level rises. With the rise in AD, the real GDP also rises.

The following figure shows, that the rise in G increases price level, and real GDP in the economy.

In the above figure, the price level is measured on the vertical axis, and the real GDP on the horizontal axis. The SRAS is the short-run aggregate supply curve of the economy, and AD₁ is the initial aggregate demand curve. The initial equilibrium price is P₁, and the initial real GDP of the economy is Y₁. After the rise in government purchases(G), the AD curve shifts rightward to AD₂. This causes a demand pull inflation.As a result, the price level rises from P₁ to P₂. The rise in AD also causes a rise in real GDP from Y₁ to Y₂.

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