MBA502, Economics for Business Apply and Discover 7.2 You are responsible for ec
ID: 1178458 • Letter: M
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MBA502, Economics for Business
Apply and Discover 7.2
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?
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.
1. A surprise increase in investment spending
In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.
To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.
2. Catastrophic floods that cause a sharp food price increase
In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.
The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.
To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).
3. A productivity decline that reduces potential output
In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.
Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.
4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States
A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports
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 surprise increase in investment spending In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index. To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity. Catastrophic floods that cause a sharp food price increase In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level. The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do. To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates). A productivity decline that reduces potential output In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines. Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further. A deep depression in East Asia that causes a sharp decrease in net exports to the United States A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports - exports less imports) will shift to the left, similar to examples in 3. Remedies are going to be similar-stimulate production through fiscal policy (increase spending or reduce taxes) or monetary policy (increase money supply and decreaseExplanation / Answer
Unfortunately I saw this with you out of time. I'm not exactly sure what you want, but
1) Looks right besides minor typos (like GDP being spelled wrong)
2) We don't necessarily know what happens to GDP, especially since we don't know if it encourages spending on fixing stuff. However it doesn't look like it asks you about that. You're right, we need to bring AD down (this will compensate by bringing the price level down to make it the same). I don't really want to question what is "good" here, we don't know what is good. The goal of the economist here is not to say what is good.
3) I still don't know why you're talking about the GDP changes. Without discussing real v nominal we can't make a statement here. I'd discuss more but out of time. AS down, AD same, PL up. Your solution is correct though.
4) It says your country. Are you the US or Asia? I think you might have it backwards, or the wording might be off. It says net exports TO the US. Which implies the US actually increased its net exports (something that is surprising given their recession). If it said FROM the US you'd be right.
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