Suppose that the government decides that economic performance is weakening, and that the government should "do something" about the situation. They make no tax changes but do enact new laws increasing government spending
programs.
a. Prior to government actions, careful studies by government economists indicated that the direct multiplier effect of a rise in government expenditures on equilibrium real GDP is equal to 6. In the 12 months since the increase in
government spending, however, it has become clear that the actual ultimate effect on real GDP will be less than half of that amount. This could have happened because of all the following except
A. direct expenditure offset.
B. an indirect crowding out.
C. a supply-side effect.
D. a short-run increase in the price level.
b. Another year and a half elapse following passage of the government spending boost. The government has undertaken no additional policy actions, nor have there been any other events of significance. Nevertheless, by the end of the
second year, real GDP has returned to its original level, and the price level has increased sharply. It is possible this happened because
A. the LRAS was vertical; the increase in government spending raised aggregate demand and resulted in only a rise in the price level in the long run.
B. the LRAS was upward-rising; the increase in government spending reduced aggregate demand and resulted in only a fall in the price level in the long run.
C. the LRAS was vertical, the increase in government spending reduced aggregate demand and resulted in only a rise in real GDP in the long run.
D. the LRAS was horizontal; the increase in government spending raised aggregate demand and resulted in only a fall in real GDP in the long run.
