Suppose that a permanent reduction in export demand were matched exactly in its first year only by increasing government spending. Compared with the long-term outcome that you would expect in the absence of this policy adjustment, you would now expect to see
A) the same downward price adjustment to accommodate lower demand postponed by one year.
B) the same downward price adjustment to accommodate lower demand operating along the same time schedule that was unaffected by neutral fiscal policy.
C) the same upward price adjustment to accommodate lower demand postponed one year.
D) the same upward price adjustment operating along the same time schedule.
E) none of the above.

Question

Quizplus · Accepted Answer

In this scenario, increasing government spending to match the reduction in export demand would temporarily offset the decrease in aggregate demand. However, since this is a one-time adjustment and the export demand reduction is permanent, the economy would eventually need to adjust to the lower level of demand. This adjustment would likely involve a downward price adjustment, but it would be postponed by one year due to the temporary government intervention.

Suppose That a Permanent Reduction in Export Demand Were Matched