Question One

Consider an economy that is in equilibrium with output equal to potential, Y*. Then the government decreases its level of purchases (G). Assume this increase in G has no effect on long run growth (i.e. potential). a) Draw an AD/AS diagram illustrating the short-run effects of this scal policy. b) On your diagram illustrate the effects of the automatic 'adjustment process', explaining why any curves shift, and identify the new long-run equilibrium in the economy