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Economics (MindTap Course List)

13th Edition
Roger A. Arnold
ISBN: 9781337617383

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BuyFindarrow_forward

Economics (MindTap Course List)

13th Edition
Roger A. Arnold
ISBN: 9781337617383
Textbook Problem

Show graphically how fiscal policy works in the ideal case.

To determine

Graphically illustrate the role of fiscal policy on economic fluctuations.

Explanation

Figure-1 indicates the role of expansionary fiscal policy when the economy faces a recessionary gap as shown below:

In Figure-1, the vertical axis measures the price level and the horizontal axis measures the real GDP. Here, at point 1, the economy faces a recessionary gap, which means aggregate demand (AD) is less than the short-run aggregate supply (SRAS). According to the Keynesian point of view, economy will not adjust itself. Therefore, the government has to introduce an expansionary fiscal policy through increasing expenditure and reducing tax revenues to eliminate the recessionary gap. An increase in spending will move the AD curve rightward from AD1 to AD2. Finally, at point 2, economy reaches the natural level of real GDP...

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