Following the wage and price adjustments, the short run AS curve shifts rightward, moving the economy towards a new equilibrium (point C) where output returns to its potential level. The price level at point C will likely be lower than at point A, reflecting the adjustment in wages and prices. Now, let's illustrate the AS-AD diagram for point c, showing the short-run impact of these combined policy actions. The AS-AD diagram illustrates the short-run impact of the combined fiscal policy actions. Initially, the economy is at potential output at point A. The aggregate demand (AD) curve then shifts leftward due to the government spending cut and tax increase, moving the economy to a new short-run equilibrium at point B. This shift represents a decrease in real GDP and a potential change in the price level, indicating a slowdown in economic activity and possibly higher unemployment.
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Following the wage and
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