With an aid of AS-AD diagram, explain the effect on price level and output when government expenditure decreases

When the government expenditure decreases, the aggregate demand decreases. The price level will decrease and the output level will decrease in the short run.

The deflationary gap will result in a downward pressure on the input prices. In the long run, wages will adjust downward and the SRAS will increase. The price level will decrease and the output will restore to its original level.