When real GDP is less than potential GDP, an increase in government expenditures will _________ Real GDP and_________ the price level.
A) increase; raise
B) decrease; raise
C) increase; lower
D) decrease; lower

Question

Quizplus · Accepted Answer

When real GDP is less than potential GDP, there is a recessionary gap which implies there are unused resources in the economy. An increase in government expenditures will increase aggregate demand, shifting the aggregate demand curve to the right. This increase in demand will lead to a higher level of Real GDP. Since there are unused resources in the economy, the increase in Real GDP will not lead to an increase in the price level, but instead, will increase output. Therefore, real GDP will increase and the price level will remain the same or may slightly increase.

When Real GDP Is Less Than Potential GDP, an Increase