Final answer:
Expansionary fiscal policy would shift AD to AD2 and SRAS to SRAS2, bringing the economy closer to full-employment level of output and raising the price level to potential GDP.
Step-by-step explanation:
The theoretical outcome of expansionary fiscal policy in an aggregate demand-aggregate supply model is that the aggregate demand (AD) curve would shift from AD to AD2. This shift represents an increase in spending either from tax cuts or increases in government spending with the intention of moving the economy closer to the full-employment level of output. Consequently, this policy would generally result in a rise in the overall price level to a new equilibrium closer to the potential GDP as indicated by the long-run aggregate supply (LRAS) curve.
The theoretical outcome of expansionary fiscal policy in the aggregate demand-aggregate supply model would be:
- The aggregate demand (AD) curve would shift from AD to AD2.
- The short-run aggregate supply (SRAS) curve would shift from SRAS to SRAS2.
- The price level would rise back to the level P₁ associated with potential GDP.
Expansionary fiscal policy, such as tax cuts or increases in government spending, is aimed at increasing aggregate demand and stimulating economic activity. This shift in aggregate demand, combined with an increase in short-run aggregate supply, helps to bring the economy closer to the full-employment level of output and raise the price level back to its potential GDP level.