Answer to Question #120892 in Macroeconomics for shilpa

Question

Assume that an economy is initially operating at the natural rate of output (full employment output). Use the AD-AS model to illustrate graphically the effects on price and output of a reduction in government spending. Explain your assumptions with respect to the range of aggregate supply of your analysis

Answer 1

Reduction is government spending will lead to alot of unemployment,which in turn results to the shift of Aggregate Supply of the commodities. The prices of commodities will go higher thus the Aggregate Supply curve shifts to the left. On the other hand,as government spending is reduced,the demand of some of the commodities will drastically reduce in the market due to their higher prices,the curve will shift to the left of the graph.