Check Your Understanding

1. Question

   The economy is operating in long-run macroeconomic equilibrium.

   1. Illustrate this situation using a correctly labeled aggregate demand–aggregate supply graph.

   2. Use your graph to show the short-run effect on real GDP and the aggregate price level if there is a decrease in government spending.

   3. What will happen to the aggregate price level and real GDP in the long run? Explain.

   4. Suppose the government is experiencing a persistent budget deficit. How will the decrease in government spending affect that deficit? Use a correctly labeled graph of the loanable funds market to show the effect of a decrease in government spending on the interest rate.