FREE IGNOU BECC-133 SOLVED ASSIGNMENT 2023-24

 

(b) How does Aggregate Demand curve changes when there is change in government spending? Does it also change equilibrium level of income and output?

A change in government spending has a significant impact on the Aggregate Demand (AD) curve and can indeed lead to changes in the equilibrium level of income and output within an economy. The Aggregate Demand curve represents the total level of demand for goods and services at various price levels within an economy.

When there is a change in government spending:

  1. Increase in Government Spending:
    • An increase in government spending directly contributes to the aggregate demand for goods and services. This is because government spending is a component of aggregate demand, along with consumption, investment, and net exports.
    • As government spending rises, the aggregate demand curve shifts to the right. This means that, at any given price level, the total demand for goods and services in the economy increases.
    • The increase in government spending can lead to a multiplier effect, where the initial increase in spending causes a ripple effect throughout the economy as increased demand stimulates higher production and income levels.
  2. Decrease in Government Spending:
    • A decrease in government spending has the opposite effect. It reduces the overall level of aggregate demand, leading to a leftward shift of the aggregate demand curve.
    • The reduction in government spending can potentially lead to lower economic activity, reduced production, and lower income levels, as the decrease in demand can have cascading effects throughout the economy.

The change in the Aggregate Demand curve can indeed affect the equilibrium level of income and output:

  • Increase in Government Spending:
    • An increase in government spending can lead to an increase in the equilibrium level of income and output. This is because the increase in demand stimulates producers to increase production, leading to higher employment and income generation.
    • The multiplier effect amplifies the initial increase in government spending, causing a larger increase in overall output and income.
  • Decrease in Government Spending:
    • A decrease in government spending can lead to a decrease in the equilibrium level of income and output. The reduction in demand can cause firms to cut back on production, leading to lower employment and income levels.
    • The multiplier effect can also work in reverse, causing a larger decrease in overall output and income.

In summary, changes in government spending directly influence the Aggregate Demand curve, leading to shifts in the equilibrium level of income and output. An increase in government spending shifts the AD curve to the right, leading to higher equilibrium income and output, while a decrease in government spending shifts the AD curve to the left, leading to lower equilibrium income and output. These changes highlight the role of government policies in shaping overall economic activity and stability.

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