Question

If large budget deficits cause the public to think there will be higher inflation in the future, what is likely to happen to the short-run aggregate supply curve when budget deficits rise?

Short answer

The short-run aggregate supply curve will shift upward when there is budget deficit.

Step-by-step solution

Step 1. Define aggregate supply.

Aggregate supply, often known as total production, is the total amount of products and services in a given economy over a certain time period at a given overall price.

Step 2. What is likely to happen to the short-run aggregate supply curve if big budget deficits encourage the public to believe that inflation will rise in the future?

When there is a budget deficit and expected inflation rises, the short-run aggregate supply curve swings upward. Inflation rises at every level of output because firms and households expect the Fed to pursue policies that cause it to do so. They will want to raise wages and prices by this amount because they do not want their real wages to fall, which accounts for inflation and is measured in the quantity of goods and services that money can buy.