Westville, a small developed country, is experiencing a very high rate of inflat

Question

Westville, a small developed country, is experiencing a very high rate of inflation. Roma Anderson, a market research analyst thinks that the high level of inflation is due to an acute shortage of goods available in the economy. According to her, the government should use expansionary fiscal policies to boost the economy. Meanwhile, Robert Simpson, a member of the finance ministry, is of the opinion that the high level of inflation is the result of excessive household spending. He suggests that the government should increase personal income tax rates to curb consumption demand. Which of the following, if true, will strengthen Roma's claim that prices are rising due to an acute shortage of goods in the economy?

Explanation / Answer

E) a severe drought in the country's agricultural belt caused considerable damage to crops and livestock this year.

A severe drought would reduce the country's overall output level and thus induce an inflation from the supply side.Thus a drought reducing the quantity of agricultural goods and livestock available in the economy would lead to their shortage and hence propel their prices to go up as demand for goods exceeds the supply.

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