Fiscal Expansion and Supply Shock Effects on Output

Steps:

• Increased budget deficit raises government spending or cuts taxes, shifting AD rightward and boosting output.
• Rise in energy costs increases production expenses, shifting AS leftward and reducing output.
• Net effect: AD shift dominates, raising equilibrium output to Y2 if fiscal stimulus outweighs supply contraction.
• Compare options: Only A combines demand expansion with a cost shock where output rises.

Why A is correct:

• Budget deficit expansion follows Keynesian fiscal policy, increasing AD via higher spending (Y = C + I + G + NX formula), outweighing AS contraction from energy costs.

Why the others are wrong:

• B: Trade deficit reduces net exports (NX down), contracting AD; indirect tax fall shifts AS right but net output likely falls.
• C: Trade surplus boosts AD, but indirect tax rise shifts AS left, netting ambiguous or lower output.
• D: Budget surplus contracts AD via reduced G; energy cost fall shifts AS right, but fiscal contraction dominates for lower output.

Final answer: A