2. Discretionary fiscal policy and multiplier effects

Consider a hypothetical economy in which the marginal propensity to consume (MPC) is 0.8. The following graph shows the aggregate demand curves (AD1AD1and AD2AD2), the short-run aggregate supply curve (SRASSRAS), and the long-run aggregate supply curve (LRASLRAS). The economy is currently at point A.

LRAS 140 SRAS 136 124 132 128 124 700, 120 PRICE LEVEL A 120 116 AD , 112 AD 108 600 700 800 900 1000 1100 1200 400 500 REAL GDP (Billions of dollars)