Exam #3 (Spring 2016) 11/12 e.In Year 1, the government increases government purchases by $500 billion. Incorporating only this additional information, clearly and accurately showin your diagrams above what, if any, effects this has on the economy’s (1) economic output, (2) inflation, and (3) exchange rate. This diagram should be drawn in REDf.Provide an economic explanationof what you have shown in your diagrams above. Discusswhat happens, if anything, to the economy’s (1) economic output, (2) inflation, and (3) exchange rate. Be sure to explain whatcauses these changes and explain whythese changes occur. . In Year 1, four events occur: First, an increase in government purchases increases aggregate demand for any given inflation. This is represented by a rightward shift of the aggregate demand curve from AD0to AD1. Economic output is higher for any given inflation. At the initial inflation of π0, there is now excess demand for goods and services in the economy, causing inflation to rise.