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, also known as domestic final supply, is the total supply of products and services that enterprises in a national economy intend to sell over a given time period.

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 predicted inflation rises, the short-run aggregate supply curve shifts upward. Inflation rises at each level of output because firms and households expect the Fed to follow policies that cause it to do so. They will want to boost salaries 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.