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?

1. A surprise increase in investment spending
2. Catastrophic floods that cause a sharp food price increase
3. A productivity decline that reduces potential output
4. 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

1) aggregate supply will increase , aggregate demand will also rise and prices will rise .u can suck money out of the system for example by increasing interest rates etc.

2) demand will increase due to speculation supply will reduce and prices will rise u can either provide subsidy or u can reduces taxes on that food item.

3)demand remains the same supply will reduce and prices will rise u should promote investments which can be done by reversing answer 1)

4) demand remains the same supply will reduce and prices will rise u can either export from other countries or u can encourage local production with in the U.S

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