Fiscal policy was introduced with the calculation of fiscal policy multipliers. It is deemed effective in the aggregate expenditure (AE) model of Chapter 3, but not in the aggregate market model of Chapter 4. Although fiscal policy increases aggregate demand (AD) in both frameworks, it raises the price level (PL) in the aggregate market model. The PL is permitted to rise when short-run aggregate supply (SRAS) slopes upward, as it does in Figure 5.1a. When the PL rises, it dampens fiscal policy’s expansionary effect on the real gross domestic product (GDP). This is not the case in the AE model because the PL is held constant when the effects of fiscal policy are analyzed. The constant PL assumption is carried over to the ...
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