Question

Expansionary fiscal policy causes inflation and no long-run boost in output if __________.

• A. the economy is producing above SRAS
• B. the economy is producing below SRAS
• C. the economy is producing above LRAS
• D. the economy is producing below LRAS

Answer 1

Option C

C. the economy is producing above LRAS

Fiscal policy is a policy used by the government to stabilize the economy. It uses taxes and government spending to stimulate or contract the economy. Expansionary policy is used to expand the economy if it is in a recession but if it is used when the economy is in the inflationary gap then that will only increase prices.

An inflationary gap is when the economy is above LRAS. The increase in spending or decrease in taxes increases the AD and shift the AD to up and increases price level exponentially as the output cannot be increased in the long run as the economy is above potential level and it increases inflation.