Highway Program in a Recession
The question
Assume the economy of Tarnholm is currently producing below its full-employment level of output. The legislature of Tarnholm passes a large highway construction program and immediately awards contracts to private firms, which begin paving and bridge work this year. Assume the central bank takes no action and that none of the new roads will carry traffic for several years. Show the effect of this program on Tarnholm's economy this year, holding all else constant. Show the effect on the Fiscal Policy (AD-AS) graph.
Equilibrium at Real GDP (Y) 92, Price Level (PL) 66
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Highway Program in a Recession: the worked answer
On the Fiscal Policy (AD-AS) graph, AD shifts right.
Why AD shifts right
Government purchases of goods and services are a component of aggregate demand, and paying private firms to pave roads and build bridges is a purchase of goods and services in the current year. Total spending is higher at every price level, and the construction wages that workers receive and respend multiply that initial increase, so aggregate demand shifts to the right. None of the roads can carry traffic for several years, so the economy's resources and technology are unchanged and long-run aggregate supply does not move. Firms' per-unit production costs are untouched, so short-run aggregate supply stays put.
What happens to the equilibrium
The equilibrium price level rises and real GDP increases, moving output back toward full employment and shrinking the recessionary gap.
The mistake students make on this one
The tempting second shift here is long-run aggregate supply, because a highway is public capital and capital sounds like capacity. Capacity moves only once that capital is finished and carrying traffic, which the stem puts several years out, so nothing Tarnholm spends this year changes its resources or technology. Shifting LRAS now also widens the recessionary gap instead of closing it, because potential output slides right while actual output stays where aggregate demand put it.
On exam day
Before you touch LRAS, ask whether the new capital is producing anything yet; if the stem says construction has only started, the money spent this year belongs to G and moves AD alone.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when AD shifts right and every other curve on the Fiscal Policy (AD-AS) 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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