When government spending (G) decreases, it leads to a leftward shift in the aggregate demand (AD) curve. To illustrate this, we can visualize the AD and aggregate supply (AS) curves on a graph. Initially, the AD curve intersects with the AS curve at the equilibrium point, determining the initial price level and aggregate output.
As government spending drops, the aggregate demand decreases because there is less financial stimulus in the economy. This decline will cause the AD curve to shift to the left, moving from AD1 to AD2. The new intersection point with the AS curve indicates a new equilibrium.
In this new equilibrium, both the price level and aggregate output are lower than before. The decrease in aggregate demand leads to reduced spending in the economy, which in turn reduces production and employment. This means that less money circulates, impacting overall economic growth and consumer confidence.
To sum it up, a decrease in government spending results in:
- A leftward shift of the aggregate demand curve (AD).
- A lower equilibrium price level.
- A decrease in aggregate output.
This situation highlights the significant role that government spending plays in maintaining economic stability and growth.