You are responsible for economic policymaking in your country. Your desire is to

Question

You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

-A productivity decline that reduces potential output
-A deep depression in East Asia that causes a sharp decrease in net exports to the United States

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

Explanation / Answer

. A surprise increase in Investment Spending- A surprise increase in investment spending
leads to increase in Aggregate demand which in turn lead to increase in price and
output. Since we need to keep prices stable at P=100 and our desire is to eliminate the
inflation.So the government can use contractionary fiscal policy or contractionary
monetary policy to decrease Aggregate demand inorder to stabilize the price at P=100.
2. Catastrophic floods that causes a sharp food price increase-since catastrophic floods
lead to decrease in the output and the increase in the price levels because of the
decrease in the Aggregate supply in the economy .So government can follow
contractionary fiscal policy or contractionary monetary policy so as to reduce the price
level and to eliminate

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.