Final answer:
The correct answer is option a. In the short run, a 50% reduction in government purchases leads to a decrease in aggregate demand, which causes both the price level and real GDP to fall.
Step-by-step explanation:
When the federal government reduces its purchases of goods by 50%, it is described as a contractionary fiscal policy, which leads to a decrease in aggregate demand. According to macroeconomic theory, a decrease in aggregate demand, in the short run, causes the price level to fall and real GDP to decline as well. Illustrated by figures such as Figure 13.5 and Figure 26.5, this scenario displays a shift in the aggregate demand curve to the left, from its original position (AD) to the new position (AD1). Consequently, as shown in the figures, there is a movement to a new equilibrium point (E1) with lower output (real GDP) and a lower price level, specifically from an output level of 500 to 450 and a price level from 120 to 115 in the examples provided.
In the long-run perspective, economies tend to adjust and return to potential GDP. The material demonstrates that with high unemployment, there would be downward pressure on wages, which in turn reduces production costs leading to a rightward shift in the short-run aggregate supply curve (from SRAS to SRAS1 in the figures), pushing the economy back to its potential output. However, this adjustment happens over time and not in the immediate short run.
The answer to the student's question in short run is: a. Both the price level and real GDP fall.