Austerity Spending Cut
The question
Assume the economy of Solenne is initially in long-run equilibrium. To reduce its budget deficit, the government of Solenne sharply cuts its purchases of goods and services. Show the short-run effect of this policy on Solenne's economy, assuming the central bank takes no action. Show the effect on the AD-AS Model graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Austerity Spending Cut: the worked answer
On the AD-AS Model graph, AD shifts left.
Why AD shifts left
Government purchases are a component of aggregate demand, so cutting them lowers total spending in the economy at every price level and shifts aggregate demand to the left. The spending cut does not alter firms' input costs, the quantity of resources, or the level of technology, so the short-run and long-run aggregate supply curves do not move.
What happens to the equilibrium
The equilibrium price level falls and real GDP declines below full-employment output, opening a recessionary gap.
The mistake students make on this one
Students sometimes shift LRAS left, arguing that a smaller government means a smaller economy. Potential output depends on the resources and technology available, which austerity does not destroy, so the fall in real GDP is a short-run gap below an LRAS that has not moved.
On exam day
After a leftward AD shift, place the new equilibrium to the left of LRAS and label that horizontal distance as the recessionary gap, since the rubric usually awards a separate point for identifying the gap.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when AD shifts left and every other curve on the AD-AS Model graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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