Suppose that the economy is experiencing the short-run equilibrium position depicted at point A in the diagram below. Then the government raises its spending and thereby runs a budget deficit in an effort to boost equilibrium real GDP to its long-run equilibrium level of $18 trillion (in base-year dollars). Explain the effects of an increase in the government deficit on equilibrium real GDP and the equilibrium price level. In addition, given that many taxes and government benefits vary with real GDP, discuss what change we might expect to see in the budget deficit as a result of the effects on equilibrium real GDP.

Transcribed Image Text:

LRAS SRAS 130- 120-- AD 0 17 18 Real GDP per Year ($ trillions)