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Using the AD-AS model, suppose climate change and dwindling water resources increase tensions between nations, causing...

Using the AD-AS model, suppose climate change and dwindling water resources increase tensions between nations, causing them to increase their military spending. What are the short and long run impacts of this policy change?

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Answer #1

Suppose the economy is in long run equilibrium which is attained at SRAS = AD = LRAS. Now, suppose there is increase in military expenditure by the government as a result AD curve will shift to the right. As a result in the short run there will be an inflatiionary gap as output will rise and price level will also rise. But in the long run wagers will revise their expectations upward which raises the SRAS upward and this will continue until the new equilibrium is not reached and at that equilibrium output remains at full employment and only price level will increase.

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