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Expansionary Policy – Fiscal and Monetary Impact on AD

Macroeconomics

This diagram illustrates how expansionary fiscal or monetary policy shifts aggregate demand (AD) rightward, increasing real GDP and the price level.

Diagram
Expansionary Policy – Fiscal and Monetary Impact on AD
Curves and Elements

ad1

AD1: Initial aggregate demand before expansionary policy.

ad2

AD2: Aggregate demand after expansionary fiscal or monetary policy.

sras

SRAS: Short-run aggregate supply curve, assumed unchanged.

lras

LRAS: Long-run aggregate supply, vertical at full employment output.

pl1

PL1: Initial price level before policy intervention.

pl2

PL2: New, higher price level after AD increases.

y1

Y1: Full employment level of output achieved through policy intervention.

Key Explanations
1

Expansionary policy is used to close a deflationary or recessionary gap by increasing aggregate demand (AD).

2

Initially, the economy is in equilibrium at AD1, SRAS, and price level PL1, with output at full employment (Ye).

3

A shift to AD2 represents the effect of expansionary fiscal policy (increased government spending or tax cuts) or monetary policy (lower interest rates, increased money supply).

4

This leads to a new equilibrium with higher output at full employment (Y2) and a higher price level (PL2).

5

The diagram demonstrates the short-run effects of policy tools on output and inflation.

Example Exam Question

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