Suppose the economy is at potential output when the government increases spending. In the long run, the economy will produce:Choose one answer from the options below.an output that is above potential output.its potential output.an output that is below potential output. its potential output at a lower aggregate price level.
Question
Suppose the economy is at potential output when the government increases spending. In the long run, the economy will produce:Choose one answer from the options below.an output that is above potential output.its potential output.an output that is below potential output. its potential output at a lower aggregate price level.
Solution
The correct answer is: its potential output.
Here's why:
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When the government increases spending, it initially stimulates the economy, causing an increase in aggregate demand.
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This increase in demand could potentially lead to an output that is above potential output in the short run, as firms increase production to meet the higher demand.
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However, in the long run, the economy cannot sustain an output level above its potential output. This is because potential output is determined by factors such as the available labor force, capital stock, and technology, which are not affected by changes in government spending.
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Therefore, in the long run, the economy will return to producing its potential output. The increased government spending may lead to a higher price level, but it does not change the economy's potential output.
Similar Questions
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